The Black Scholes model is a widely used mathematical model for pricing options.
It is based on the principle that the value of an option is determined by the volatility of the underlying asset, the time remaining until expiration, the strike price of the option, and the risk-free interest rate.
The Black 76 Model
The Black model, also known as the Black-76 model, is a popular option pricing model among professional quant traders. It is essentially a variant of the Black-Scholes model that replaces the spot price with the forward price as the underlying asset.
This model assumes that interest rates and dividend rates are always adjusted in futures prices, which simplifies the calculation of option prices.
Traders must make certain assumptions to use the Black model –
- The assumptions include no interest rate and no dividend.
- The model uses future prices instead of stock prices.
- The Black model is preferred by many traders due to its simplicity and accuracy.
- It accounts for the volatility skew commonly observed in the market.