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:
“The most passionate, consistent, extreme and implacable enemy of the Enlightenment and ... all forms of rationalism ... was Johann Georg Hamann. His influence, direct and indirect, upon the romantic revolt against universalism and scientific method ... was considerable and perhaps crucial.”
—Isaiah Berlin (b. 1909)
“Relying on any one disciplinary approach—time-out, negotiation, tough love, the star system—puts the parenting team at risk. Why? Because children adapt to any method very quickly; today’s effective technique becomes tomorrow’s worn dance.”
—Ron Taffel (20th century)
“The country needs and, unless I mistake its temper, the country demands bold, persistent experimentation. It is common sense to take a method and try it. If it fails, admit it frankly and try another. But above all, try something. The millions who are in want will not stand idly by silently forever while the things to satisfy their needs are within easy reach.”
—Franklin D. Roosevelt (1882–1945)