Most option traders understand what Black Scholes does, although they don’t really know how to use it. For those who don’t know, Black Scholes is a model used to calculate the theoretical fair value of an option contact. Theoretical being the key word.

Fair value is based on the market’s view as to how volatile the underlying security is likely to be, between now and the time the option expires. Making it particularly useful to the MX trader who is charged with providing liquidity for traders.

It is also useful for retail investors, because it can help frame a decision to buy or sell an option. Based on whether investors believe the market is overstating or understating future volatility. Make no mistake, an assumption about volatility is as important to an options trader as an assumption about future earnings is to a stock analyst.

To add some meat to this bone, recognize that you can implement a bullish or bearish position on the underlying security by either buying or selling an option contract. For example, if you were bullish on the outlook for the underlying security you could buy a call. That is, assuming you believe the call is cheap, which is to say, you think that traders are understating future volatility.

If you think the option is expensive – i.e. the market is overstating future volatility – you can also take a bullish position by selling options. You could, for example, implement a covered call write or sell an uncovered put. Either position would be profitable if the underlying security rises, although the potential profit is limited to the net premium received.

The MX provides investors with a Black Scholes calculator at www.m-x.ca. Just click “Options Calculator” and follow the steps.

You can also insert the Black Scholes formula into an Excel spreadsheet. Something that investors have asked me to do for some time.

With that in mind, I have included a Black Scholes Excel template that anyone can use. Feel free to manage your own calculations by simply inputting data into the “grey” cells. The cells with formulas are locked, although you can look at the formulas in the formula bar.