The Black-Scholes model, also known as the Black-Scholes-Merton model, is a mathematical model used to price options contracts, including both call and put options. It was developed by Fischer Black and Myron Scholes in 1973 and later expanded by Robert Merton.
The Black-Scholes model assumes that the price of an underlying asset follows a log-normal distribution and that the option contract can be hedged by buying and selling the underlying asset and the risk-free asset. The model also assumes that there are no transaction costs, no restrictions on short selling and that the risk-free interest rate is constant over the option’s life.
The Black-Scholes model has widely used in the financial industry to price and trade options contracts. However, it has been criticized for its assumptions, particularly the assumption of a constant risk-free interest rate and the assumption of log-normal distribution for the underlying asset. In practice, these assumptions may not hold, and there may be other factors that affect the pricing of options contracts. As a result, many variations of the Black-Scholes model have been developed to address some of these limitations.