We are independent & ad-supported. We may earn a commission for purchases made through our links.

Advertiser Disclosure

Our website is an independent, advertising-supported platform. We provide our content free of charge to our readers, and to keep it that way, we rely on revenue generated through advertisements and affiliate partnerships. This means that when you click on certain links on our site and make a purchase, we may earn a commission. Learn more.

How We Make Money

We sustain our operations through affiliate commissions and advertising. If you click on an affiliate link and make a purchase, we may receive a commission from the merchant at no additional cost to you. We also display advertisements on our website, which help generate revenue to support our work and keep our content free for readers. Our editorial team operates independently from our advertising and affiliate partnerships to ensure that our content remains unbiased and focused on providing you with the best information and recommendations based on thorough research and honest evaluations. To remain transparent, we’ve provided a list of our current affiliate partners here.

What Are Derivative Pricing Models?

John Lister
By
Updated May 16, 2024
Our promise to you
SmartCapitalMind is dedicated to creating trustworthy, high-quality content that always prioritizes transparency, integrity, and inclusivity above all else. Our ensure that our content creation and review process includes rigorous fact-checking, evidence-based, and continual updates to ensure accuracy and reliability.

Our Promise to you

Founded in 2002, our company has been a trusted resource for readers seeking informative and engaging content. Our dedication to quality remains unwavering—and will never change. We follow a strict editorial policy, ensuring that our content is authored by highly qualified professionals and edited by subject matter experts. This guarantees that everything we publish is objective, accurate, and trustworthy.

Over the years, we've refined our approach to cover a wide range of topics, providing readers with reliable and practical advice to enhance their knowledge and skills. That's why millions of readers turn to us each year. Join us in celebrating the joy of learning, guided by standards you can trust.

Editorial Standards

At SmartCapitalMind, we are committed to creating content that you can trust. Our editorial process is designed to ensure that every piece of content we publish is accurate, reliable, and informative.

Our team of experienced writers and editors follows a strict set of guidelines to ensure the highest quality content. We conduct thorough research, fact-check all information, and rely on credible sources to back up our claims. Our content is reviewed by subject matter experts to ensure accuracy and clarity.

We believe in transparency and maintain editorial independence from our advertisers. Our team does not receive direct compensation from advertisers, allowing us to create unbiased content that prioritizes your interests.

Derivative pricing models are techniques used by investors to try to find an objective measure of a derivative's true value. This is then compared to its actual market price to see whether it represents a worthy investment. Each model takes into account different known factors that affect the derivative. While derivative pricing models operate in an objective manner, the selection of the factors covered by the model is itself subjective.

A derivative is a financial agreement based on an underlying asset. In most cases, this agreement is based on a transaction to take place on a future date involving the asset, but with a price fixed in advance. The difference between the agreed price for the transaction and the actual market price of the underlying asset at the time of the transaction usually determines which party in the deal makes a profit. Examples of derivatives include futures agreements, options agreements and swaps. Once a derivative agreement is made, the parties involved can sell their interest in it, which known as trading the contract.

Somebody considering buying a derivative will need to determine an acceptable price to pay, taking into account the risk the deal presents and the potential rewards. One way to do this is to use derivative pricing models. These attempts to work out what a "fair" price would be for the derivative at the present moment. This can then be compared to the current market price for the derivative, which is determined by demand and supply.

One of the best known derivative pricing models is the Black-Scholes Option Pricing Model. This takes into account six factors. These factors are: how long the derivative has left to run before the transaction date, the current price of the underlying asset, the fixed transaction price under the derivative, what dividends the investor is missing out on by buying a derivative rather than the underlying asset itself, the interest saved by not having to pay for the underlying asset immediately, and the volatility of the underlying asset.

While the concept of the model is relatively simple, the mathematics used to make the calculation is relatively detailed, and producing a chart showing the range of potential "fair" prices involves a three-dimensional graph. Fortunately, computer programs make it much easier to calculate values using derivative pricing models. Such programs also allow variations on models, whether than means switching to a completely new model, or tweaking an existing model to give greater emphasis to an individual factor.

SmartCapitalMind is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
John Lister
By John Lister , Former Writer
John Lister, an experienced freelance writer, excels in crafting compelling copy, web content, articles, and more. With a relevant degree, John brings a keen eye for detail, a strong understanding of content strategy, and an ability to adapt to different writing styles and formats to ensure that his work meets the highest standards.

Discussion Comments

John Lister

John Lister

Former Writer

John Lister, an experienced freelance writer, excels in crafting compelling copy, web content, articles, and more. With...
Learn more
SmartCapitalMind, in your inbox

Our latest articles, guides, and more, delivered daily.

SmartCapitalMind, in your inbox

Our latest articles, guides, and more, delivered daily.