American Options Pricing Model

The binomial options pricing model is an option pricing approach used to price American-style options. An American option is a financial contract that can be exercised at any time up to and including on the expiration date. This contrasts with a European option, which can only be exercised on the expiration date.

The binomial model assumes that:

• There is a known constant interest rate (r) over the life of the option
• Volatility is constant over the life of the option.

The binomial model consists of a recursive method in which the value of an option at time "t" is computed from the value of the option at time "t-1". Note that the binomial method is path-independent.

The binomial model was implemented in the calculator below.

Input

Please enter the following input parameters:

• Spot Price: price of the underlying asset
• Strike Price: strike of the option contract
• Risk-Free Rate: risk-free rate
• Volatility: volatility of the underlying asset
• Dividend Yield: continuous dividend yield of the underlying asset
• Time to expiration in years: time to maturity of the option contract

Output

The calculator returns the following results:

• Price: fair value of the option contract
• Paths of the stock price

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Originally Published Here: American Options Pricing Model