Virtually all binary option trading today is done with the help of the Black-Scholes model. This model was first created in 1973 by Fischer Black and Myron Scholes and it is used across the board when dealing with binary options. It includes a very complicated and detailed mathematical formula that can be viewed online on many sites and in finance books. Here, we will discuss the basics of the Black-Scholes model and of how it can help people with binary option trading.
Binary Options with Black-Scholes
Basically, with binary options trading, we are trying to predict what the price of a contract will be in a certain amount of time. Let's say we have 5 chocolate bars. We want to predict in a certain and specific time if the 5 chocolate bars will go up in price or if they will go down in price and by how much. The Black-Scholes model helps us to make that prediction and to find the value of a contract for the future. It helps us to see the probability (the chance) of a stock price ending up at a certain point over a certain amount of time.
The Black-Scholes model for binary option trading has a number of assumptions that it works with. It assumes that the stock won't pay dividends during the time you've set. It also assumes that the European terms are the ones that will be used for the binary options trading. The European terms only allow the stock or other item to be exercised (finished) on the expiration date that you pre-arranged. There are other assumptions that the Black-Scholes model has as well. It assumes that people can't predict how the market will be in the future and it does not have a commission as part of the transaction. The understanding with the Black-Scholes model for binary options trading is that there won't be a commission added onto the price, even though there usually is a commission when people trade.
More Assumptions with Black-Scholes
The Black-Scholes model also says that interest rates will stay steady and that returns will be distributed in a regular and consistent way. With all of these parts of the Black-Scholes model, there is then a very detailed and complicated formula that financial analysts use to see if their binary option will go up in the time frame they've set, or if it will go down; and by how much it will change. All of this is very complicated and uses an incredibly detailed series of math equations. For our purposes, all that we need to know is that it very accurately predicts that future price for binary options trading and helps people to make decisions about investing in binary options. Binary options trading has become that much easier to understand and to do with the Black-Scholes model.