The Black-Scholes Options Pricing Model and its Implications on the Underlying Security Market

The options market plays an important role in the world of investments. Particularly, option data may be used to explain activity in the underlying security. This paper provides a discussion on the option market and underlying security market, questioning whether information from the options market can be used to explain efficiency in the markets for their underlying securities. Three models are presented that measure market efficiency through bid-ask spreads as the dependent variable with use of implied volatility from the Black-Scholes options pricing model as an independent variable in two of these models, while being omitted from a third model. These models are created with the help of five previous empirical studies. Regressions are run on these models and results suggest that the implied volatility variable from the Black-Scholes model can be used to explain efficiency in the underlying security market. The findings of this paper support the findings of previous literature than suggest that the options market can be used to explain activity in the underlying security market