The binomial options pricing model is an option pricing approach used to price American-style options. An American option is a financial contract that can be exercised at any time up to and including on the expiration date. This contrasts with a European option, which can only be exercised on the expiration date.
The binomial model assumes that:
- There is a known constant interest rate (r) over the life of the option
- Volatility is constant over the life of the option.
The binomial model consists of a recursive method in which the value of an option at time “t” is computed from the value of the option at time “t-1”. Note that the binomial method is path-independent.
The binomial model was implemented in the calculator below.
Input
Please enter the following input parameters:
- Spot Price: price of the underlying asset
- Strike Price: strike of the option contract
- Risk-Free Rate: risk-free rate
- Volatility: volatility of the underlying asset
- Dividend Yield: continuous dividend yield of the underlying asset
- Time to expiration in years: time to maturity of the option contract
Output
The calculator returns the following results:
- Price: fair value of the option contract
- Paths of the stock price
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