Definition Binomial Option Tree

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Binomial Option Tree

An Option Pricing method which assumes that the price of the underlying can go up or down by fixed multiples. Each price jump is assigned a probability and a tree of possible underlying prices is built. Working from the tree points or nodes at the option maturity date, the worth of the option can be back calculated until the option can be valued at the desired date. This technique is commonly used to price path dependent options, such as average rate and lookback options, where the option price is dependent on the underlying's price history. A more advanced technique, the Trinomial tree, as its name suggests, assumes that option prices cam move up, down or stay the same.

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