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:
“Too poor for a bribe, and too proud to importune,
He had not the method of making a fortune.”
—Thomas Gray (1716–1771)
“I do not know a method of drawing up an indictment against a whole people.”
—Edmund Burke (1729–1797)
“The method of authority will always govern the mass of mankind; and those who wield the various forms of organized force in the state will never be convinced that dangerous reasoning ought not to be suppressed in some way.”
—Charles Sanders Peirce (1839–1914)