Option Pricing Theory

The option pricing model was first developed by Myron Scholes and Fischer Black and extended by Robert Merton.

For a standard stock option, option pricing theory expresses the value of an option as a function of five factors: the stock price, the exercise price, the time until expiration, the risk-free rate of interest, and the riskiness of the stock.  The value of an option increases with the riskiness of the stock.

Option pricing theory has been extended to the analysis of other types of financial instruments.  In addition, other kinds of non-financial contracts and investment opportunities can be understood by using the insights of option pricing theory.