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Volatility is the most difficult parameter to estimate (all the other parameters are more or less given). It is your job to decide how high volatility you expect and what number to enter – neither the Black-Scholes model, nor this page will tell you how high volatility to expect with your particular option. Being able to estimate (= predict) volatility with more success than other people is the hard part and key factor determining success or failure in option trading. The important thing here is to enter it in the correct format, which is % p.a. (percent annualized).

Risk-free interest rate should be entered in % p.a., continuously compounded. The interest rate’s tenor (time to maturity) should match the time to expiration of the option you are pricing. You can interpolate the yield curve to get the interest rate for your exact time to expiration. Interest rate does not affect the resulting option price very much in the low interest environment, which weve had in the recent years, but it can become very important when rates are higher.

Dividend yield should also be entered in % p.a., continuously compounded. If the underlying stock doesnt pay any dividend, enter zero. If you are pricing an option on securities other than stocks, you may enter the second country interest rate (for FX options) or convenience yield (for commodities) here.

Time to expiration should be entered as % of year between the moment of pricing (now) and expiration of the option. For example, if the option expires in 24 calendar days, you will enter 24/365=6.58%. Alternatively, you may want to measure time in trading days rather than calendar days. If the option expires in 18 trading days and there are 252 trading days per year, you will enter time to expiration as 18/252=7.14%. Furthermore, you can also be more precise and measure time to expiration to hours or even minutes. In any case you must always express the time to expiration as % of year in order for the calculations to return correct results.

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