Pricing Options Using Binomial And Trinomial Methods

Pricing Options Using Binomial And Trinomial Methods

Pricing Options, Published in the 1970s, the Black-Scholes-Merton model provided an entirely new definition for the financial option market, half a century later the Binomial tree option pricing model was published, and that is the true key that allows the option market to be generalized to the world. Based upon the Binomial model, the Trinomial option pricing model was built to reduce possible errors and persons thus expected it to be a better approach. Still how much better is the Trinomial model, and is it worth spending the time on calculations?

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These will be the key comparisons provided in this dissertation. The comparisons are based upon computer calculating time used, and approximation error. An illustrative example is used to build the data base for further comparison of the convergence speed of these two models. All the values are calculated using the Matlab program and Casio calculators in order to provide examples of the assumption that the Trinomial option pricing model is a better model in reducing the approximation error, but takes much longer than the Binomial tree model to get the results.

The emergence of financial derivatives in the 1970s marked a highly significant and exciting event in the history of finance. Options trading began in the United States and European markets in the late eighteenth century, and over the last 20 years, options played a key role in all financial derivatives.

The option price was an old question for the financial world. Back in the 1900s Louis Bachelier published his academic dissertation “Théorie de la speculation�? (Theory of Speculation), which became known by the public as the milestone of modern finance. The “random walk theory�?, which built a random model of the stock price’s changing pattern and how it follows in the stock market, was first applied in his paper. In 1964, Paul Samuelson (Nobel Prize in Economic Science winner) revised L.Bachelier’s model, and instead of the stock price he used stock returns to eliminate the negative figures which might occur in L.Bachelier’s model. Based upon this new model P.Samuelson also studied the Call Option pricing problem, and built a pricing equation for it. Although the equation was quite a beauty to watch, it could not be used in real world dealings since two of the main factors depended upon the investor’s personal predilection.

Futures and options are traded actively on many exchanges throughout the world. Before any certain systematization models of the option had been created it was impossible for people to evaluate any kind of option price in a common way. Any approximations of the price based trader’s personal experience would well likely result in mistakes. The………..

Pricing Options Using Binomial And Trinomial Methods

Pricing Options Using Binomial And Trinomial Methods