Now that we are familiar with both the Monte Carlo Simulation and option concept, we can move on to determining a way to apply Monte Carlo in option pricing. The are a numerous option pricing models, each with specific assumptions that apply to specific option types, but the most famous is the Black-Scholes model and we will cover this model at a later date in order to compare the results of Monte Carlo Simulation to the results obtained by applying Black-Scholes model (which is believed to be one of the most exact option pricing model).
We’re going to apply the Monte Carlo simulation to calculate the value of an European call option (an options that gives the right to buy shares only at a specific date in the future!), because Black-Scholes can be applied only to European options (one of its limits) and we have to be able to compare the results and see the error rate.
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