Option valuation: key issues in option pricing

In this paper we attempt to address, in a non‐technical way, the basic assumptions underlying option pricing theory and point out some of the inherent weaknesses they imply in the reliability of the resulting valuations. We present several concrete examples to illustrate the impact of the modeling assumptions and selecting input parameters for the models. We point out the importance for anybody involved in derivatives business to be aware of such issues and encourage them to obtain at least a superficial understanding of the quantitative aspects of option pricing.