Black-Scholes

• The only variable to Black-Sholes that cannot be measured from the market is the volatility of the underlying, as the volatilty in question is the volatility from the present to the expiration of the option.
• The theory can be worked in reverse, using the market price of the option as an input, and getting out a volatility figure. This volatility is called implied volatility.
• The theory is immensely popular. Some people believe it mostly works because people use it so much to determine what they want to buy. Another sign of its popularity is that in some markets, prices are usually quoted as implied volatility (using Black-Sholes) instead of directly.
• The theory assumes that the distribution of future prices is a Gaussian curve around the present price. This is a simplification; securities prices have a "fat tailed" distribution, meaning that extreme price moves are more likely than in a gaussian distribution (extreme moves down are also more likely than extreme moves up.)
• The theory assumes that dividends are paid continiously (which they are not.)

A lesser known fact about the Black-Scholes thing is that these two Nobel prize winner professors, Prof. Black and Prof. Scholes were both employed by the hedge fund LTCM (Long Term Capital Management) which went broke in 1998 through derivatives plays that went seriously wrong. LTCM had to be bailed out by a gathering of high powered banks galvanized by nothing short of the US Federal Reserve Bank.