Contents

The Black-Scholes Merton model ...............................................................................................................2

Calculating the European call option ...............................................................................................................3
The impact upon options markets ...................................................................................................................3
Black–Scholes in practice .............................................................................................................................4
Challenges and criticism of the Black Scholes Model ......................................................................................5
General Problems .............................................................................................................................................5
Black Scholes Merton model & Python ............................................................................................................6
Stock Analysis .................................................................................................................................................7
Stock Visualisation............................................................................................................................................7
Data is only as good as its presentation ........................................................... Error! Bookmark not defined.
References ............................................................................................................................................................8

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Few models make the world stand up and take notice, and this is one of them – 'The Black–Scholes
model'. It is a mathematical model simulating the dynamics of a financial market containing derivative
financial instruments. The model's main theory is to hedge the options in an investment portfolio by
procuring and selling underlying assets (such as stock) in just the right way to eliminate risk. The
method has later become known within the financial industry as "continuously revised delta hedging"
and adopted by many leading investment banks and hedge funds.
The BSM formula led to a boom in options trading and widely used. This model helps us find the price
of an option, a European option, to be precise.

The Black-Scholes Merton model

The Black–Scholes Merton model is a mathematical model simulating the financial market
comprising derivative monetary instruments such as futures, options, swaps and forwards. The vital
property of the model is that it shows that an option has a unique price irrespective of the risk of the
underlying security and its expected return—the model based on a partial differential equation (PDE),
the so-called Black-Scholes equation. One can comprehend the Black-Scholes formula, which gives a
theoretical estimate of the correct price of European stock options.

The Black-Scholes-Merton model is the most widespread option pricing model used when it comes to
European options. It has two distinct formulas for determining the call option and the put option.
The Factors for calculating the call option are :
St – Current Price of the underlying asset K
– Strike Price r – Risk-free rate (continuously
compounded) σ – Volatility of returns
T-t – Time to maturity (in years)
N – Cumulative distribution function of Normal Distribution

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Calculating the European call option
To calculate the price of a European call option, we need the below values are:
1. Current price of the stock (S),
2. Price of the call option (X),
3. Time to expiration (T - t),
4. Risk-free interest rate (r)
5. Volatility of the stock, given by the standard deviation of historical log returns (σ)

Take an example of a call option for 'A' stock ($XyXy), maturing the day of its Q3 earnings in 2021 at
a price 20% higher than the stock is currently trading. Looking at 'A' NASDAQ listing ($XyXy) on
Yahoo Finance today (July 3, 2021), the price of S = $245. Multiplying the current price with 1.2
provides us with a price 20% higher than the stock is currently trading at, X = $294. We realize that
the day of its Q3 earnings call is October 22, giving time to expiration/maturity of October 12 - July 3
= 100 days. For the risk-free interest rate, we used a 10-year government bonds rate paying 2.12%.
Then, we find the values, S = 245, X = 294, T - t = 101 and r = 0.0212. The only missing value is the
stock's volatility (σ) rate.

A stock's volatility is estimated by calculating other option prices for the same stock at different
expiration/ maturity dates (T) and strike prices (X) if we know they are set according to the BSM
model. The resultant value, σ, is a number between 0 and 1, indicative of the market's suggested
volatility for the stock. The value averaged at approximately 0.38 for 4–5 different option prices around
the same expiry/maturity date for the above stock. Input into the equation above, we find that the call
option we're interested in should be priced at approximately around $7.

The impact upon options markets

Options have been traded informally in what is known as "over the counter" markets for centuries. As
late as 1973, the first trading of options at an exchange was the Chicago Board Options Exchange
(CBOE). Thus there was a happy coincidence between the arrival of the analytical understanding of
options and the development of market institutions to trade-in options. Within just a few months after
the Black–Scholes paper was published, Texas Instruments started selling hand calculators, which
could evaluate the Black–Scholes formula! Today, every MBA student in the world is taught the
Black–Scholes formula.

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Black–Scholes in practice

Black–Scholes Merton model is widely used due to:

• Simple to calculate a valid approximation, particularly when analyzing the trend in which
prices move when intersecting critical points.
• A strong basis for further enhancements
• Flexible, as the model's original price, output, can be used as an input and one of the other
variables solved for; the implied volatility calculated in this way is often used to quote option
prices (that is, as a quoting convention).

The first point is self-evidently practical.

Useful approximation: Although volatility is not constant, results from the model are often helpful in
setting up hedges in the correct proportions to minimize risk. Even when the results are not entirely
accurate, they serve as a first approximation to adjustments.

The robust base for further enhanced models: The BSM model can be modified to deal with some
of its failures. Rather than considering some parameters (such as interest rates or volatility) as constant,
one considers them as variables, and thus additional causes of risk. The other deficiencies are not
diminished by altering the model, particularly liquidity risk and tail risk. They are instead managed
outside the model, chiefly by minimizing these risks and stress testing.

Explicit modelling: This element means that, rather than presuming a priori volatility and calculating
prices from it, the model can be used to resolve volatility, which provides the indicated volatility of an
option at given prices and durations by determining for volatility over a given set of durations and
strike prices. In applying the BSM model, a coordinate conversion from the price realm to the volatility
realm achievement. Instead of citing option prices in terms of dollars (which are hard to compare across
strikes, coupon frequencies and durations), option prices are mentioned in terms of suggested
volatility, which leads to trading of volatility in option markets.

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Challenges and criticism of the Black Scholes Model

• Constrained to the European market: The Black-Scholes-Merton model is an accurate

determining factor of European option prices. It does not precisely value stock options in the
US. The reason is that it presumes that options can only be applied on their maturity/ expiration
date.
• Risk-free interest rates: The model presumes constant interest rates, but it is barely ever the
reality.
• Assumption of a steady marketplace: Trading generally comes with transaction costs such as
commission, brokerage fees, etc. However, the BSM model assumes a frictionless market, that
there are no transaction costs which is not the reality in the trading market.
• No returns: The BSM model assumes no returns, no interest earnings and no dividends
associated with the stock options. However, it is not the case in the actual trading market. The
buying and selling of options are primarily focused on the returns.

General Problems
The Black–Scholes analysis, and the field of continuous-time finance, is a powerful technology for
dealing with various financial instruments. In all cases, differential equations defining the price of the
asset of interest can be derived. Still, usually, it is not possible to find analytical solutions to these
equations (the call option on a non–dividend-paying stock, which led to the celebrated formula above,
is a rare exception). In these cases, computers are used to solve the differential equations and thus
obtain prices.

Options have existed for centuries, but a significant constraint upon their usefulness was the enormous
difficulties of their pricing. In a world where extremely little was known about how options should be
priced, trading options were a mixture of guesswork and gambling. Significantly few economic agents
participated in options markets. With the analytical capabilities created by Black, Merton and Scholes,
the option has become a mainstream instrument, with millions of users worldwide being able to think
about option pricing meaningfully.

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Black Scholes Merton model & Python
• The Black Scholes Merton model was a turning point in the options world who finally had a
mathematical foundation to build their options portfolios.
• The BSM also gave rise to several option hedging strategies, which are still implemented.
• Python is one of the prevalent languages, has tons of powerful libraries for application
development, an easy to understand syntax and is quite close to Mathematical syntax.
• Mathematical/algorithmic statements can generally be interpreted into a few lines of Python
codes.
• In that sense, Python provides the best of both worlds: high-level abstraction and rigorous
execution.

Python has been earning significant traction in the financial industry over the last years, and for a good
reason.

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Stock Analysis
Stock markets are ever-changing and unpredictable. People have attempted to tame the bull all through
history, with hardly any success. Stock market prediction is complicated because of the excessive
dynamics and to consider such variances is practically unfeasible. However, advances in machine
learning and computing have allowed the processing of large amounts of data.

Stock Visualisation

Nowadays, organizations collect a vast amount of data; hence data visualization is an integral part of
business activities. All of the data collected hold vital insights for businesses, and visualizations make
these insights easy to interpret. Using visualizations is the most straightforward approach to absorb
and analyze data. Visuals help to effortlessly understand the complex problem, identify relationships,
patterns, and outliers in the data. It also helps in understanding business problems better and develops
a captivating story based on visuals. Comprehensions gathered from the visuals help in building
strategies for businesses.

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References
The Black-Scholes formula, explained | by Jørgen Veisdal .... https://www.cantorsparadise.com/the-
blackscholes-formula-explained-9e05b7865d8a
Implied Volatility: What, Why & How!. https://blog.quantinsti.com/implied-volatility/ Black-Scholes-
Merton Model - Overview, Equation, Assumptions.
https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/black-scholes-
mertonmodel/
Book Review: 'We Need a Nice New Goddess'.
https://www.outskirts.arts.uwa.edu.au/__data/assets/pdf_file/0003/2950905/Outskirts-Jordan.pdf Black–
Scholes model - Wikipedia. https://en.wikipedia.org/wiki/Black%E2%80%93Scholes_model
Black–Scholes | Trader Wiki | Fandom. https://trader.fandom.com/wiki/Black%E2%80%93Scholes Option
pricing using the Black-Scholes model, without the .... https://towardsdatascience.com/option-
pricing-using-the-black-scholes-model-without-the-formula-e5c002771e2f Where
we can calculate d 1 and d 2 with the following ....
https://www.coursehero.com/file/p7lg88dr/Where-we-can-calculate-d-1-and-d-2-with-the-
followingformulae-Where-%CF%83-is-the/
Black-Scholes-Merton Model - Overview, Equation, Assumptions.
https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/black-scholes-
mertonmodel/
The Complete Guide to Asperger's Syndrome by Tony Attwood.
https://www.goodreads.com/book/show/72242.The_Complete_Guide_to_Asperger_s_Syndrome Learn
Python: Python Programming for the Absolute Beginner ....
https://bootcamp.berkeley.edu/resources/coding/learn-python/
Python for Finance, Part I: Yahoo & Google Finance API ....
https://www.learndatasci.com/tutorials/pythonfinance-part-yahoo-finance-api-pandas-matplotlib/
Stock Market Analysis with Python Pandas, Plotly and .... https://griddb.net/en/blog/stock-market-
analysiswith-python-pandas-plotly-and-griddb/

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