Binomial Method in Option Price - Assignment Example

The step by step procedure in option valuation using the Binomial method, explains the simplicity and accuracy of the method. The Binomial method tree generation has been implemented in Excel software and has been tested with some historical data collected. The results show that the valuation of European and American options with the Binomial option tree method proves that this method is a better predictor of the future prices of options. This chapter intends to introduce the research background and related concepts.

The main research question, supporting hypotheses are to be explained in detail. Also, the scope and limitations of this research are detailed in this chapter. The crash of the stock markets in October 1987 and the major variations in stock market prices in 1998 indicate the uncertainty and instability associated with the stock market transactions. Large variations in shares or prices have become common events in asset markets, even in developed countries that are economically sound. This has led to the study of variations in the measures of different stock market parameters, very much valuable.

These parameters are seen to be the perfect indicators of the market variations and hence market risks. In such a scenario, the market information that could be obtained from asset prices has been gaining interest in the recent past. One main reason for the importance of these asset prices is that many households have started investing heavily in stock markets. Thus, the asset price falls and the consequent negative effects on profit tend to show large impacts on the financial market’s climate.

Not only households, but there are also many small and medium-sized firms that have large investments on assets in the stock market. Hence their growth and economy all depend on the stock market situation. For such firms to have financial stability, it seems important that the analysis of the downside risks of these asset portfolios.