Option Pricing Theory

Option pricing theory refers to the various academic theories built into models that explain the pricing and valuation of financial options and how likely it is that an option will expire with value to the option writer. The theories take into account the current price of underlyings, the stock’s implied volatility, the option expiry date, and interest rates -- all of which determine the option premium. The Black-Scholes Model, the binomial options model, and Monte Carlo simulation model are the most widely adopted options models that result from options pricing theory.