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 good husband finds method as efficient in the packing of fire-wood in a shed, or in the harvesting of fruits in the cellar, as in Peninsular campaigns or the files of the Department of State.”
—Ralph Waldo Emerson (1803–1882)
“I have a new method of poetry. All you got to do is look over your notebooks ... or lay down on a couch, and think of anything that comes into your head, especially the miseries.... Then arrange in lines of two, three or four words each, don’t bother about sentences, in sections of two, three or four lines each.”
—Allen Ginsberg (b. 1926)
“As a science of the unconscious it is a therapeutic method, in the grand style, a method overarching the individual case. Call this, if you choose, a poet’s utopia.”
—Thomas Mann (1875–1955)