Answer:
The Black-Scholes option pricing formula is used widely in practice, especially by international banks in trading OTC options.
Step-by-step explanation:
The Black-Scholes option pricing formula is used to calculate the fair price of a call or put option. It is done by considering six variables:
- volatility
- type of option
- underlying stock price
- time
- strike price
- risk-free rate
The price for a risky asset (e.g. private corporation stock) is calculated against the price of a risk free asset (e.g. government bond). It can only be used to set a price for European options since American options can be exercised before the expiration date which doesn't fit into the fixed variables of the formula.