Binomial options pricing model

The Binomial options model provides a generalisable numerical method for the valuation of options. It was first proposed by Cox, Ross and Rubinstein (1979).

The binomial model uses a "discrete time framework" to trace the evolution of the key underlying variable, via a binomial lattice (tree) - the given evolution then forms the basis for the option valuation. In general, the value of the option, dependent on option style, at any node in the lattice, given the price of the underlying at that node and the value of the option at the later nodes, is determined using the risk neutrality assumption. The procees is iterative, starting at each final node, and then working backwards through the tree to t=0, where the calculated value is the value of the option in question.

See Investment Basics: XXXVIII. Options pricing using a binomial lattice from The Investment Analysts Society of South Africa: http://www.moneymax.co.za/articles/displayarticlewide.asp?ArticleID=272347