# Option Pricing Theory Definition.

Option pricing theory is a branch of financial economics that deals with the pricing of options and other derivative securities. It is based on the premise that the price of an option is determined by the underlying security's price, the option's strike price, the time to expiration, the level of interest rates, the volatility of the underlying security's price, and the dividend yield.

What are the two option pricing models? The two option pricing models are the Black-Scholes model and the Binomial model.

The Black-Scholes model is a mathematical model that is used to determine the fair price or theoretical value for a call or put option. The model takes into account several factors, including the time to expiration, the underlying asset's volatility, the interest rate, and the strike price.

The Binomial model is a simplified version of the Black-Scholes model. It is used to price options where the underlying asset only has two possible outcomes (hence the name "binomial"). The model is easy to use and understand, but it only works for relatively simple option contracts. How do you choose strike price in options trading? When choosing a strike price for options trading, there are a few things to consider. First, you need to decide what type of option you are looking to trade - a call option or a put option. A call option gives you the right to buy the underlying asset, while a put option gives you the right to sell the underlying asset.

Once you have decided what type of option you want to trade, you need to choose a strike price. The strike price is the price at which the underlying asset will be bought or sold if the option is exercised. The strike price is usually close to the current market price of the underlying asset.

You also need to consider the time frame in which you want to trade. Options have a limited lifespan and will expire at a certain date. The closer to expiration, the less time the option has to move in your favor.

Finally, you need to decide how much you are willing to risk. Options are a risky investment and can lose all of their value if the underlying asset moves in the wrong direction.

When choosing a strike price, you need to balance all of these factors. The best strike price is one that gives you a good chance of making a profit while also not being so risky that you could lose all of your investment.

What is option pricing formula? The option pricing formula is a mathematical formula used to determine the theoretical value of an options contract. The formula takes into account the underlying asset's price, the strike price of the option, the time to expiration, the volatility of the underlying asset, and the interest rate.

### What is Black-Scholes option pricing model?

The Black-Scholes model is a mathematical model of a financial market in which traders buy and sell assets, typically stocks or commodities. The model is used to price options, which are contracts that give the buyer the right to buy or sell an asset at a certain price on or before a certain date.

The Black-Scholes model is based on the assumption that the market is efficient, meaning that prices reflect all available information. This means that prices move up and down in response to news and events, but they do not move randomly.

The model is named after its creators, Fisher Black and Myron Scholes, who first published it in 1973. What are the five fundamental parameters of option pricing model? The five fundamental parameters of option pricing model are:

1. The underlying asset's price
2. The strike price
3. The time to expiration
4. The underlying asset's volatility
5. The interest rate