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+Price vs. Value: How Traders Use
+Option-Pricing Models
+Like in the common-life example just discussed, the right to buy or sell an
+underlying security—that is, an option—can have value, too. The specific
+value of an option is determined by supply and demand. There are several
+variables in an option contract, however, that can influence a trader’s
+willingness to demand (desire to buy) or supply (desire to sell) an option at
+a given price. For example, a trader would rather own—that is, there would
+be higher demand for—an option that has more time until expiration than a
+shorter-dated option, all else held constant. And a trader would rather own a
+call with a lower strike than a higher strike, all else kept constant, because it
+would give the right to buy at a lower price.
+Several elements contribute to the value of an option. It took academics
+many years to figure out exactly what those elements are. Fischer Black and
+Myron Scholes together pioneered research in this area at the University of
+Chicago. Ultimately, their work led to a Nobel Prize for Myron Scholes.
+Fischer Black died before he could be honored.
+In 1973, Black and Scholes published a paper called “The Pricing of
+Options and Corporate Liabilities” in the Journal of Political Economy ,
+that introduced the Black-Scholes option-pricing model to the world. The
+Black-Scholes model values European call options on non-dividend-paying
+stocks. Here, for the first time, was a widely accepted model illustrating
+what goes into the pricing of an option. Option prices were no longer wild
+guesswork. They could now be rationalized. Soon, additional models and
+alterations to the Black-Scholes model were developed for options on
+indexes, dividend-paying stocks, bonds, commodities, and other optionable
+instruments. All the option-pricing models commonly in use today have
+slightly different means but achieve the same end: the option’s theoretical
+value. For American-exercise equity options, six inputs are entered into any
+option-pricing model to generate a theoretical value: stock price, strike
+price, time until expiration, interest rate, dividends, and volatility.