How many traders use Black-Scholes? I find myself questioning whether it is worth any more than an academic theory about option pricing. Let’s not forget when this paper was first published, 1973. Back then there were hardly any calls available, and for public trading, no puts at all.
There has been a lot published since 1973 expanding on Black-Scholes. But it is still considered the starting point for valuation. Even so, I find several flaws in the model itself. First, it is based on European-style expiration. Second, the assumption is based on a risk-free interest rate, and that is questionable as well. Third, the model makes no allowance for hedged positions, synthetics, or rolled contracts.
One variable may be troubling to statisticians. Multiple variables should be troubling to the rest of us. Even so, what else do we have? It may be time to create a new, revised, updated pricing model that brings onto the field a few less-than-variable items.
About this week’s Heavy Hitter
Michael C. Thomsett is a widely published options author, with six options books in print, published by John Wiley & Sons, FT Press, Amacom Books, and Traders Library. He blogs at FT Press and his website is www.MichaelThomsett.com.