What Is a ‘Black Scholes’ Model and How Is Volatility a Key Input?

The Black-Scholes model is a mathematical model used to estimate the fair price, or theoretical value, of European-style options. Volatility, specifically the expected future volatility of the underlying asset (implied volatility), is a crucial input.

Higher volatility increases the probability of extreme price movements, which in turn increases the potential payoff of an option, thus raising its theoretical price.