Hello all blog readers,
Today I will discuss my readings “On Valuing American Call Options with the Black-Scholes European Formula” and “Tests of the Black-Scholes and Cox Call Option Valuation Models: Discussion” The reason I have chosen the first reading is because I believe I must learn about the initial assumptions of Black-Scholes. I have chosen the second reading to familiarize myself with other models and their comparisons with Black-Scholes. In order to understand this, you must know a little about the 5 inputs of Black-Scholes and what they mean. If you don’t, please read the according information online.
Takeaways from the first reading:
“On Valuing American Call Options with the Black-Scholes European Formula”:
Empirical finds prove “biases” have been found related to the exercise price, the time to maturity, and the variance.
Black-Scholes systematically underpriced deep out-of-the-money options and near-maturity options while it overpriced deep in-the-money options during the 1973-1975 period.
The original exercise price biases have been found to reverse themselves during certain time periods, so that both in- and out-of-the-money call options can be over- or underpriced by the Black-Scholes model depending on the sample of data being analyzed. More consistently, the model has been found to underprice near-maturity options.
Takeaways from the second reading:
“Tests of the Black-Scholes and Cox Call Option Valuation Models: Discussion“:
The Cox equation is a special case of Black-Scholes making it at least as good at predicting option prices.
Neither equations can properly predict American options.
My personal takeaways:
The technical math relating to options are much more difficult than I originally imagined. Please read said texts if you want to see what I mean. However, through these readings, I believe I have learned a lot about the biases and assumptions Black-Scholes incorporates and this will definitely help me as I am creating my Excel Spreadsheet.
Thanks for reading.