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The Skinny on Options: Abstract Applications

The Binomial Option Pricing Model

The Skinny on Options: Abstract Applications

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

In the world of option pricing, there are sophisticated models that determine the fair price for a given option’s value. The most popular of these is the Black Scholes Model, but it is not the only alternative for determining option prices. Another very commonly used model is the Binomial Option Pricing Model.

This model uses a decision-tree analysis, working backwards from the option’s final value at expiration, to arrive at its current value. Interestingly, we learn today that this method for solving equations is similar to that of high-level economics modeling. And lastly, we see that the Binomial Option Pricing Model might be more applicable than the Black Scholes Model, when it comes to American options.

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