Method
The binomial pricing model traces the evolution of the option's key underlying variables in discrete-time. This is done by means of a binomial lattice (tree), for a number of time steps between the valuation and expiration dates. Each node in the lattice represents a possible price of the underlying at a given point in time.
Valuation is performed iteratively, starting at each of the final nodes (those that may be reached at the time of expiration), and then working backwards through the tree towards the first node (valuation date). The value computed at each stage is the value of the option at that point in time.
Option valuation using this method is, as described, a three-step process:
- price tree generation,
- calculation of option value at each final node,
- sequential calculation of the option value at each preceding node.
Read more about this topic: Binomial Options Pricing Model
Famous quotes containing the word method:
“A method of child-rearing is not—or should not be—a whim, a fashion or a shibboleth. It should derive from an understanding of the developing child, of his physical and mental equipment at any given stage, and, therefore, his readiness at any given stage to adapt, to learn, to regulate his behavior according to parental expectations.”
—Selma H. Fraiberg (20th century)
“Too poor for a bribe, and too proud to importune,
He had not the method of making a fortune.”
—Thomas Gray (1716–1771)
“I am not afraid of the priests in the long-run. Scientific method is the white ant which will slowly but surely destroy their fortifications. And the importance of scientific method in modern practical life—always growing and increasing—is the guarantee for the gradual emancipation of the ignorant upper and lower classes, the former of whom especially are the strength of the priests.”
—Thomas Henry Huxley (1825–95)