Theoretical Pricing Models: Binomial Option Pricing and the Black-Scholes Formula

What is the theoretical price of an option,

Member Sign-In Theoretical Price The theoretical price of an option is the fair value of the option as determined by an option pricing model.

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This model such as the Black-Scholes model takes into account current values such as implied volatilitythe price of the underlying, the strike priceand time to expiration to determine what an option should be worth. Each of the input values fluctuate, which means theoretical price will also be a fluctuating value.

A trader can use theoretical price to determine what should be a fair price before trading an option.

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A Theoretical Pricing calculator uses an option pricing model to determine what theoretical price may be given adjustments for price, time, and volatility. In the picture below, Theo Price has been added to the option chain and input boxes appear for the available adjustment variables.

Using the Theo Price Tool to Figure Out Premium Expectations

Expected Price An expected price is a similar tool whereby a pricing model generates an estimated value of the underlying instrument where an option order may be filled. For example, bidding on XYZ call options a few cents beneath theoretical value will likely require the price in the underlying stock to decline to a certain level, referred to as the expected price.

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