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:
“Protestantism has the method of Jesus with His secret too much left out of mind; Catholicism has His secret with His method too much left out of mind; neither has His unerring balance, His intuition, His sweet reasonableness. But both have hold of a great truth, and get from it a great power.”
—Matthew Arnold (1822–1888)
“The method of scientific investigation is nothing but the expression of the necessary mode of working of the human mind. It is simply the mode in which all phenomena are reasoned about, rendered precise and exact.”
—Thomas Henry Huxley (1825–95)
“Steady labor with the hands, which engrosses the attention also, is unquestionably the best method of removing palaver and sentimentality out of one’s style, both of speaking and writing.”
—Henry David Thoreau (1817–1862)