Introduction
Black, Scholes and Merton’s famous option price formula wasn’t a new discovery, as shown in the next section. The formula was well know at the time and widely used in the option market. Often it is noted that option trading took off after the publication of the Black-Scholes formula, but this simply is not true... however, the reverse is. In 1973 the Chicago Board Options Exchange (CBOE) opened for business as the first option exchange in the world, making options widely available. This and the introduction of handheld calculators, to do the necessary computations for Black and Scholes, made the formula a success. The formula may not have been a break through, but the way it was derived certainly was. Using the risk free portfolio was the step that made the known formula acceptable to academia. The derivation of the formula is the topic of this note based on research I did for a class on derivatives. Continue reading →