Determinant of Black Scholes Model

How a decrease in the value of each of the determinants of the option price

An option’s price is affected by a variety of factors in the financial markets. The Black-Scholes Option Pricing Model is an approach for calculating the value of a stock option. The Black-Scholes option pricing model is used to determine the equilibrium value of an option. It provides insight into the valuation of debt relative to equity. (Siegel et al, 1998).

In the Black-Scholes model, the call option is determined by the prevailing share price, the strike price of the option,the time to expiration of the option, the risk-free interest rate corresponding to the time remaining on the option, the volatility in share price. The changes of these variables will have an impact on the prices of the option pricing model.

Firstly, stock price changes have immediate and significant effects on the prices of the call options. As a stock price increases, the call option will increase because the option is approaching the adjusted intrinsic value. As the stock price decreases, the price of the call option will decrease because the immediate exercise of the stock would not be profitable. The option price changes less than the stock price, but the percentage change in the option price is greater than the percentage change in the stock price. (Daigler, 1993 ).

Secondly, the exercise price has also effect on the value of the call option. An decrease in the strike option will increase the value of the call option. For call option, the lower the strike price,the more beneficial it is for the buyer. As options are struck at lower exercise prices, they will become more useful for the buyer to profit from the call option. For instance, consider two call options, X and Y assuming X with a strike price of $25 while Y with a strike price of $30. If these two options are available, any buyer would like to pay the minimum possible amount and consequently they will choose option X over option Y....