Running head: BLACK-SCHOLES

Black-Scholes Pricing Model

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BLACK-SCHOLES

When the evolution of trading took place in the 1970s, two professors including Fischer
Black and Myron Scholes wrote an article that would guide individuals on pricing options. At
that time the paper by Fischer Black was considered very significant because a tremendous effort
was seen taking place as part of articulating pricing options. This is because it was based on the
assumption that there was a risk-free interest rate (Henderson, 2004). This method is still used
today when determining what options would be worth. It is also used in the academic sector.
However, most people have realized that Black- Scholes pricing model is flawed in many ways.
This paper discusses how Black- Scholes pricing model is flawed.
Some of the assumptions in the formula do not reflect the day to day economic markets
and conditions. Calculations on assumed interest-free rate are questionable when one consider
buying and selling activities of today. This is questionable whether such rates exists today. The
black-Scholes is based on European style options where a date of analysis remains the same until
the expiration date. This is a factor that every trader knows that it is not accurate.
The third assumption that makes Black- Scholes pricing formula to have flaws, is the
pricing options that can only be done on the last trading day as the Europeans. Some of the
options that are traded publicly can be closed any time before the expiration date. This changes
the calculations of the price.
Trading options rely on the study of volatility as far as the market is concerned and where
the variability is found on the value of premiums. When these are put into consideration, then
best selection of trading options would be inevitable.

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References
Henderson, T. (2004). Fixed Income Strategy. Chichester: John Wiley & Sons.