Cd= Value of call if stock price isSd
In a multiperiod binomial process, the valuation has to
proceediteratively,thatis,startingwiththelasttimeperiod
andmovingbackwardsintimeuntilthecurrentpointintime.
Theportfoliosreplicatingtheoptionarecreatedateachstep
andvalued,providingthevaluesfortheoptioninthattime
period. The final output from the binomial option pricing
modelisastatementofthevalueoftheoptionintermsofthe
replicatingportfolio,composedofΔshares(optiondelta)of
the underlying asset and risk-free borrowing/lending.
ILLUSTRATION A12.1: Binomial Option Valuation
Assumethattheobjectiveistovalueacallwithastrikeprice
of50,whichisexpectedtoexpireintwotimeperiods,onan
underlyingassetwhosepricecurrentlyis$50andisexpected
to follow a binomial process:
Now assume that the interest rate is 11%. In addition, define