Probably the most famous formula in finance is what’s called the Black-Scholes Model and it’s a model to help value options. The inputs below are what go into the Black-Scholes model.
- Underlying asset price: The current price of the underlying asset on which the option is based can have a significant impact on the value of the option contract.
- Strike price: The strike price of the option, which is the price at which the underlying asset can be bought or sold, also affects the value of the option.
- Time to expiration: The length of time until the option contract expires can impact its value. Generally, the longer the time to expiration, the higher the option price will be.
- Volatility: The volatility of the underlying asset’s price can have a significant effect on the option’s value. Higher volatility can increase the likelihood of the option being exercised and can increase the option’s price. What affects volatility? General market conditions, such as economic trends, geopolitical events, and other factors, can impact the value of the option. In addition to company specific factors like earnings, analyst forecasts, changes in growth, etc.
- Interest rates: Changes in interest rates can affect the value of options, particularly those with longer time horizons.
- Dividend yield: The dividend yield of the underlying asset can also impact the value of options, particularly for options on stocks that pay dividends.
-Paul R. Rossi, CFA