What Is the Black-Scholes Model and What Are Its Main Limitations When Applied to Crypto Options?

The Black-Scholes model is a mathematical model used to estimate the fair price of European-style options. It considers five inputs: the underlying asset's price, strike price, time to expiration, risk-free interest rate, and volatility.

Its main limitations in crypto are the assumption of continuous trading, constant volatility, and a normal distribution of returns. Crypto markets are non-normal, experience extreme jumps, and have high transaction costs, violating the model's core assumptions.