Teaching applications of Monte Carlo simulation to European option pricing

The option pricing model has widespread applications related to both financing and investing decisions in financial as well as commodity markets. However, the Black-Scholes option pricing model is not a user-friendly numerical method and it is often very complicated for students to understand. This paper demonstrates the merits of using a simulation technique as a viable, easy-to-use alternative. Specifically, it provides a pedagogical approach that could be used in teaching applications of Monte Carlo simulation to stock option valuation. It, thus, serves as an interdisciplinary teaching note that can be accessed by both finance and operations management instructors to support student learning of the option pricing model as well as Monte Carlo simulation. The paper reviews the applications of the Monte Carlo approach in option pricing, highlights the value added efficiency that the technique generates and, finally, discusses the limitation and extensions of the Monte Carlo approach in option pricing.