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I always wondered why the Black-Sholes-Merton model was used to estimate the price of European-style options when their prices are available on quoted exchanges?

I think I am missing something big here so any help would be great!

Thanks.

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The market price tells you what price you can currently buy/sell based on supply and demand. The Black-Scholes model is one way of estimating the fair market value. If they don't agree, then you may conclude that it's a good time to buy or sell.

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Part of the reason is that OTC (over the counter) options aren't publicly quoted (obviously). Another part is that the implied volatility on the option is not a measurable input to the BSM model but is the volatility used in hedging a portfolio by minimizing volatility.

  • its EoD on Friday, I had 2 pints for lunch and have a pile of OTC options issues to sort... I'll fill out this answer a bit later – MD-Tech Mar 11 '16 at 17:25

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