From a good intention

A Bad Used Innovation

by Mohamed Hanini

Mohamed Hanini is a PhD candidate at Polytechnique School of Montreal in Stochastic Simulation. 

Mohamed Hanini is a PhD candidate at Polytechnique School of Montreal in Stochastic Simulation. 

"The Pricing of Options and Corporate Liabilities", is very famous paper in the economic and financial world, published in the Journal Of Political Economy in 1973, by Fisher Black and Myron Sholes. They derived an analytical model, which estimates the price of the option over time. An option is a financial contract which gives the buyer (the owner) the right, but not the obligation, to buy or sell an underlying asset at a specified strike price before a specified date. The key idea behind the model is to cover (or hedge) the option by buying and selling the underlying asset in just the right way and, as a consequence, to eliminate risk. In other words, some compagnies could buy this project to protect themselves against the rise of a price of one of a significant fixe cost. As an example, we can illustrate options on kerozene which Air Canada could use to protect its cash flows against the increase of the kerozene prices. Hedge Funds and Investment Banks use Delta Technics, which is the basis of more complicated hedging strategies.

Unfortunately, these products are used now by traders for speculation purposes, then they were responsable of two financial collapses in 1987 (was named Black Monday) and in 2008.