Calculate up state factor in binomial pricing model
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The binomial option pricing model is another popular method used for pricing options.
Examples
Assume there is a call option on a particular stock with a current market price of $100. The at-the-money (ATM) option has a strike price of $100 with time to expiry of one year. There are two traders, Peter and Paula, who both agree that the stock price will either rise to $110 or fall to $90 in one year’s time.
They agree on expected price levels in a given time frame of one year but disagree on the probability of the up or down move. Peter believes that the probability of the stock's price going to $110 is 60%, while Paula believes it is 40%.
Based on that, who would be willing to pay more price for the call option? Possibly Peter, as he expects a high probability of the up move.
Calculations
The two assets, which the valuation depends upon, are the call option and the underlying stock. There is an agreement among participants that the underlying stock price can move from the current $100 to either $110 or $90 in one year’s time, and there are no other price moves possible.
Examples
Assume there is a call option on a particular stock with a current market price of $100. The at-the-money (ATM) option has a strike price of $100 with time to expiry of one year. There are two traders, Peter and Paula, who both agree that the stock price will either rise to $110 or fall to $90 in one year’s time.
They agree on expected price levels in a given time frame of one year but disagree on the probability of the up or down move. Peter believes that the probability of the stock's price going to $110 is 60%, while Paula believes it is 40%.
Based on that, who would be willing to pay more price for the call option? Possibly Peter, as he expects a high probability of the up move.
Calculations
The two assets, which the valuation depends upon, are the call option and the underlying stock. There is an agreement among participants that the underlying stock price can move from the current $100 to either $110 or $90 in one year’s time, and there are no other price moves possible.
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