Chapter 03 · Section 3.1

Calculation

The Black and Scholes model uses a similar calculation method. The difference comes from the number of possible stock values: it is not a fixed set but a continuous interval. The stock can take any value from zero to infinity.

Obviously, not all the possible values have the same probability. The Black and Scholes model uses a "lognormal" probability distribution.

We will now look at a graphical example illustrating the calculation method and how the shape of the probability distribution affects the option's fair value.