If you know exactly what this is because you know what the This traded for $3 just now." So you actually canįigure out what this is, which raises a very, very You know what these two things are, and you could say, "Hey, look. Option with this stock price, this exercise price. Traded all of the time, and so you could actually look Going to be constant over the life of this option. Intrinsic property as this volatility that's Grabs whether there is, whether you can even as assume that there's some constant Knowing the actual intrinsic and it's even up for Well, that's all interesting,īut it's very important to know that this is an estimate. Returns over some time period "where that security has notĬhanged in some dramatic way?" And then use that as the input, and then they wouldĬome up with some price. Has historically been "the standard deviation of log Would normally do it is they'll say, "Okay, what Looking at the history of the standard deviation of log returns. You can at least attempt to estimate it is by Now, one of the assumptionĪbout Black-Scholes Formula is that this is a constant thing. Measure the standard deviation of log returns. Now let's think a littleīit about volatility, so how do you actually Thing's going to expire, so that's pretty straightforward. The time to expiration, well you know that, you know what today's date is. The risk-free interest rate, there are good proxies for it, money market funds, there's government debt, things like that, so that's pretty easy to figure out, or at least approximate. The exercise price, well, that's part of the contract. So it sounds all very straightforward, and some of this is straightforward. You the appropriate price for this European call option. The standard deviation of the log returns, if you give me these six things, I can put these into theīlack-Scholes Formula, so Black-Scholes Formula, and I will output for We already got an overview that if you give me a stock price, and an exercise price, and a risk-free interest rate, and a time to expiration and the volatility or
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