The Simplicity of the Black Scholes Pricing Model

Welcome to Issue 066 of Masters in Trading Digest.

Let’s start with a birds-eye view of the S&P 500 Futures going back 3 years.

This chart shows the “expected move” of the S&P 500 Futures for each month going back 3 years.  In the middle (above), notice the Close In % sits close to 90%?  

That means 90% of the time, the S&P 500 Futures closes within its expected move bands.

The chart above was shared yesterday afternoon in our Discord channel. This is the community where options members gather so we can interact with each other during the trading day.

Notice how the S&P 500 Futures rally right up to the lower end of its “expected move”?

Because options have gamma and need to be hedged around the outer expected move bands we expect these key levels to be support and resistance. Traders should not be surprised when the market gets rejected at this lower band as it did this morning.

The takeaway:

Options are priced and move because of volatility.

The Black Scholes options pricing model is the most widely followed method to price options and only uses 5 inputs:

1. Price
2. Time
3. Volatility
4. Interest Rate
5. Strike

The only input not provided FREE from Mr. Market is #3; volatility.  That’s how important it is.