EXPLICIT CLOSED-FORM SOLUTION OF BLACK-SCHOLES EQUATION AND ITS APPLICATION TO CASH-OR-NOTHING BINARY OPTIONS

2024/06/11 by Adindu-Dick, Joy Ijeoma
#Black-Scholes equation #Diffusion equation Fourier Transform #Option pricing

paper · doi:10.60787/jnamp-v67i1-343

Abstract

This work deals with the explicit closed-form solution of Black-Scholes equation and its application to cash-or-nothing binary options. We first transform the Black-Scholes equation into a diffusion equation by change of variables. We then apply the Fourier Transform method to find the general solution of the diffusion equation. Finally, we establish an explicit closed-form solution for binary options. Hence, for a call (put) option, one gets the discounted risk neutral probability that the stock price is above (below) the strike price at time.

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