What is Black-Scholes Model?
The Black-Scholes model is a closed-form option pricing formula for European-style options on non-dividend-paying shares. It takes five inputs: share price, strike, time to expiry, risk-free rate and expected volatility, and produces a theoretical fair value for the option.
How It Works
- Gather the five inputs (price, strike, time, rate, volatility).
- Plug them into the Black-Scholes formula for a call or a put.
- Use the result as a benchmark for traded prices or for IFRS 2 valuation.
- Switch to a binomial model for American-style or path-dependent features.
Saudi Context
Saudi listed companies disclose Black-Scholes assumptions in their IFRS 2 notes for employee stock options, including share price at grant, expected term, volatility and risk-free rate.
Example
For a one-year European call with share at SAR 100, strike SAR 100, risk-free rate 4 percent and volatility 25 percent, Black-Scholes returns a fair value of about SAR 11.