Black-Scholes and algorithms

Trading and risk have always been intertwined, with merchants constantly seeking ways to reduce their exposure to unforeseen events, writes Philip Stafford. As the Dutch Golden Age of the 17th century began, merchants in Amsterdam and Antwerp began using options – which gave the holder the right to buy or sell a security at a set price – as an insurance. Similar products such as warrants were traded on stocks in Wall Street in the 1920s, but were never “mathematically” priced.

That changed in 1973. Two US academics, Fischer Black and Myron Scholes, backed by a third, Robert Merton, published a paper that contained a model to calculate fair market value for call options. It gave traders a supposedly objective method of comparing option prices.