I understand this is very basic question but I still scramble to determine what would be right risk free rate to price a simple European call option using Black-scholes formula, with maturity is 5 years. This option is written on a USD based stock?
I have below choices
- US Treasury rate with maturity 5 years (because, this coincides with option maturity)
- US Treasury rate with maturity 3 years (because, people told me that this would be most liquid)
- Overnight Fed fund rate
What will be the most accurate choice for my case?
Also, should I convert the reported rate to Continuously compounded rate? Because, if I look into the Black scholes formula it considers continuously compounded rate.
Any pointer will be very helpful.