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:
“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)
“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)
“You know, I have a method all my own. If you’ll notice, the coat came first, then the tie, then the shirt. Now, according to Hoyle, after that the pants should be next. There’s where I’m different. I go for the shoes next. First the right, then the left. After that, it’s every man for himself.”
—Robert Riskin (1897–1955)