What parameters to use in Black-Scholes Calculator ?

This item was filled under [ FAQ, Option Pricing ]

For calculating option price, Black-Scholes model is one of the most popular one. This uses following parameters to calculate the premium (or current fair value) of option

1) Price of Underlying
2) Option strike Price
3) Days Until Expiration
4) Risk free Interest Rate
5) Dividend Yield
6) Historical Volatility

Users are often confused about what values to be used for these parameters.

Here is outcome of the sensitivity analysis of varoius factors that affect option pricing. (factor by which calculated option premium will change for change in one of the parameter)

- 10 Rs change in underlying approximate change in premium is 6 Rs.
- 1 day change in expiry (14 to 13 and so on) the approximate change in premium is 5 Rs.
- 1 % change in Historical Volatily (39 to 40 and so on) the approximate change in premium is 3 Rs.
- 0.5 % change in risk free rate (3 to 3.5 and so on) the approximate change in premium is 0.8 Rs.
- 1 % change in dividend (1 to 1.25 and so on) the approximate change in premium is 0.5 Rs.

Keeping this sensitivity in mind, most important is to use right Underlying price, strike price and days till expiry.  They are factual and quite obvious hence one can’t go wrong with them..

One can get Historic Volatilty number for NIFTY from NSE site. It keeps changing daily but a range of 35% to 40% is reasonable.

As the effect of dividend and Interest rate is very minimum, so you can use any sensible number, it doesn’t make much difference.

Hope this helps in removing some of your doubts.  As always, feel free to leave your comment/doubt below.

Happy Trading

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