The Black-Scholes Financial Model
What every trader should know about the founding fathers of binary options
The important Black-Scholes economics formula for discerning the value or price of commodities options as they move across the market was first defined and established by Fischer Black and Myron Scholes in the 1970s. In the 40 or so years that have passed since its inception, this has become the leading principle of price valuations for many investors and sectors in the financial world, and has been broadly adopted by many people who trade in options, particularly binary options.
The Black-Scholes valuation has been credited with helping to launch the rapid growth in options trading by making it easier to predict where prices will go in a volatile market. The boom is expected to sustain itself for the foreseeable future thanks to the rise in Internet technology that allows people to trade binary options on their home computers.
As a sign of its importance in the world of economics, the Black-Scholes valuation served as the foundation for the Nobel Prize in Economics awarded to Myron Scholes. Fischer Black would have also been recognized but had already passed away and was therefore not eligible.
Understanding the The Black-Scholes Valuation
The Black-Scholes valuation applies only to European style options, which can only be exercised on their expiration date. These contrast with American style options, which can be exercised any time before the expiration date. The Black-Scholes formula, however, applies to both call and put options. It also assumes that there are no broker fees in buying or selling the option, which makes it applicable to the trade in binary options through the Internet.
Basically, Messrs. Black and Scholes' formula recognizes that prices of commodities: forex currency, gold, oil, silver, stocks or market indices, normally fluctuate up and down, with small shifts that are highly probable and large changes in price progressively whose probability is lower as the changes increase in size. The Black-Scholes formula gives a statistical probability that the commodity will reach certain highs and lows during a particular time based on its standard volatility and other factors.
The Black-Scholes Formula and Binary Options
The Black-Scholes valuation is especially useful for trading binary options. Since the goal of a binary options trade is the be in-the-money when the option expires, the Black-Scholes formula can determine if the probability of that happening is with you or against you. Since Black-Scholes seeks the fair valuation for both buyer and seller, it does not depend on significant outside factors to influence the price of the commodity option. It therefore gives you a hint as to whether you should buy the option to go up or to buy it to go down. Achieving Black-Scholes formula expertise is a great way to build up tremendous leverage as a trader of binary options.