Black-Scholes

In the early 1970s, Fischer Black and Myron Scholes made a major breakthrough by deriving a differential equation that must be satisfied by the price of any derivative dependent on a non-dividend-paying stock. By employing the technique of constructing a risk neutral portfolio that replicates the returns of holding an option, Black and Scholes produced a closed-form solution for a European option's theoretical price.^[8] At the same time, the model generates hedge parameters necessary for effective risk management of option holdings. While the ideas behind the Black-Scholes model were ground-breaking and eventually led to Scholes and Merton receiving the Swedish Central Bank's associated Prize for Achievement in Economics (often mistakenly referred to as the Nobel Prize),^[9] the application of the model in actual options trading is clumsy because of the assumptions of continuous (or no) dividend payment, constant volatility, and a constant interest rate. Nevertheless, the Black-Scholes model is still one of the most important methods and foundations for the existing financial market in which the result is within the reasonable range.^[10]