What Is Binomial Options Model?

The binomial options model is a financial model used to price options. The model uses an iterative approach, allowing for the determination of option prices at each node in the tree. The model was first proposed by Cox, Ross and Rubinstein in 1979.

The model starts with one period (t=0) and then divides time into discrete periods, or “nodes.” For each node, there are two possible outcomes: either the stock price goes up by a certain amount, or it goes down by a certain amount. These two outcomes are represented by the two branches emanating from each node.

At each node, the expected value of the stock price is equal to the weighted average of the two possible future stock prices, discounted back to the present. The weighting is determined by the probability of each outcome occurring.

The model can be used to price options on stocks, commodities, currencies, and other assets. It is particularly useful for pricing options with multiple exercise dates or “knock-out” features.

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