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Derivatives

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  • July 30, 2022
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Fair Value of an Option

According to the Black-Scholes model, it refers to the premium which makes both the option seller and buyer break even. The fair value doesn’t account for the effect of transaction costs (like commissions) and never adjusts for risk. In other words, fair value is a theoretical, model-derived estimate of the option value in an efficient market. In that sense, the fair value estimation would be expected to divert from empirical value, or the price at which the option will actually trade.

It is also called fair value premium.


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