BINOMINAL OPTION

PRICING MODEL

BOPM
 BOPM…1
BOPM >> 2 Characteristics::
 DISCRETE TIME

UP µ
BINOMINAL Generation
DOWN d
 µ = eσ . √T/n
 d = e-σ . √T/n
 BSOPM…2
• ASSUMPTIONS::
1.Length of time period is same
2.Volatility is constant
3.Transition probe (TP) is constant
4.Trees re-combe
 BSOPM…3
• Spot price is Rs::100/-; Strike price is Rs 105/-;
Volatility is 25%; RFR 5%, Time 3 steps.

µ = eσ . √T/n e 0.25 . √ 1/3 = 1.1553

d = e-σ . √T/n = 0.8656

T0 T1 T2 T3

154.14

133.47

BSOPM…4
115.53
115.53

100 100.00

86.58 86.58

74.96

64.86

Up= 1.1553; down = 0.8656

 BSOPM…5
• Tp = e r.(t/n) – d
µ-d

• e 0.05.(1/3) – 0.8656 = 0.5219

1.1553 - 0.8656
T0 T1 T2 T3

154.14 –
105= 49.14

133.47

115.53 115.53 –
105 =10.53

100 100.00

86.58 ( <St)
86.58 = ‘0’

74.96
64.86 ( <St)
= ‘0’

Call = e –r.t {p.(cu) + (1-p) cd}

T0 T1 T2 T3

49.14

30.204
2

10.53

15.404
8

Call = e –0.05.1/3 {0.5219.(49.14) + (1-0.5219) .10.53} = 30.2042

Call = e –0.05.1/3 {0.5219.(10.53) + (1-0.5219) .0} = 15.4048
T0 T1 T2 T3

105 - 86.58
= 18.42

105-64.86
=40.14
Call = e –0.05.1/3 {0.5219.(18.42) + (1-0.5219) .40.14}
Call = e –0.05.1/3 {0.5219.(0) + (1-0.5219) .18.42}