Knowledge

Binomial Option Pricing Model

A method to calculate possible paths that might be followed by the underlying asset's price over the life of the option. The model works by dividing the time to expiration into a number of time intervals and over each time interval, the model assumes that the price of the underlying moves up or down to certain values. Then from the up or down prices at the next time step, the up and down price is calculated for each scenario until the expiry date. The magnitude of these moves is determined by the volatility of the underlying and the length of the time interval.