Binomial Options Pricing Model

Binomial Options Pricing Model was introduced in 1979 by three eminent persons, John C.Cox, Stephen Ross and Rubinstein from the field of economics and finance. This model offers a generalizable mathematical process for evaluating the options.
A discrete-time pattern of changing prices for a certain period of time of a particular financial tool is used by the Binomial Options Pricing Model. After this, the option is evaluated through the use of risk-neutrality presumption over the entire time period of the option, as the cost of the particular financial tool develops.

The Binomial Options Pricing Model is very efficient in handling different types of situations. It is not possible for every model to deal with a variety of finacial situations simultaneously. Because of this special feature, the Binomial Options Pricing Model is used for different purposes.

Another characteristic of the Binomial Options Pricing Model is that it models the particular financial tool over time and not at a definite point. The Binomial Options Pricing Model minimizes the chances of fluctuation in the options cost.
The assumption of an appropriate market is also used by this model. At the same time, the model also reduces the option duration.

The utility of Binomial Options Pricing Model can be seen in both the American and Bermudan options, though both are different from each other. The Bermudan options can be traded at different points but the American options are tradable at any point. Apart from these differences, the model is applicable to both of these very effectively. On the other hand, the model is very simple and can be used in computer software without any difficulty.

The Binomial Options Pricing Model is not as fast as the other models like Black-Scholes model and so on. However, the accuracy of this particular model is much higher than others. Again, the binomial model is very effective for the longer dated options and some other options like one that is provided on dividend yielding securities.

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Last Updated on : 1st July 2013

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