How Does the Black-Scholes Model Account for Volatility Skew? ⎊ Path

How Does the Black-Scholes Model Account for Volatility Skew?

The original Black-Scholes model assumes volatility is constant for all strikes and expirations, meaning it does not inherently account for volatility skew. In practice, traders use a modified approach where they input a different implied volatility for each strike price to align the model's output with actual market prices, effectively using the model as a calculator based on the observed skew.

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Glossar

Implied Volatility

Expectation ⎊ This value represents the market's consensus forecast of future asset price fluctuation, derived by reversing option pricing models using current market premiums.

The Black-Scholes Model

Foundation ⎊ The Black-Scholes model serves as the cornerstone for modern options pricing theory, providing a continuous-time framework for calculating the fair value of derivatives.