Any one of the mathematical formulas used to fairly price an option contract as a result of many factors, including: the underlying security's prevailing price, beta, Implied Volatility, time to expiry, dividends expected, current risk free interest rate, etc.
The Risk-free interest rate is the return on investment with no loss-of-capital risk. In practice, this does not exist. In theory, it is an important parameter in option pricing as it sets the baseline price upon which risk premium should be added. A practical estimate to the risk-free interest rate is taken from 'risk-free' bond issued by the government or agency where the default risk is practically zero.
The Black Scholes or Black Scholes Merton model is a mathematical model used to estimate the price of European Style derivatives, including options contracts. The model forms the basis of the Black-Scholes formula, which can be rewritten in different forms to solve for various options trading parameters. [click to read more]
The options price curve created on a graph by plotting option's price against period of time passed. This curve, created by a mathematical model, is important for option traders as it depicts the time value at different fixed points in time.[click to read more]