What is the Binomial Option Pricing Model?

[@RyanOConnellCFA]

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[@MrMenok]

You have been my primary educator for my entire finance curriculum, keep up the amazing work!!!

[@RyanOConnellCFA]

Thank you so much for this comment, it really means a lot to me!

[@gabewhitten2155]

Thanks Ryan, this has helped me greatly with estimating the future value of my portfolio hedges.

[@RyanOConnellCFA]

Glad it was helpful! Thanks for the feedback

[@maxmustermann5369]

Nicely explained certainly better than in the lecture I really like your channel sir

[@RyanOConnellCFA]

Hey Max, I really appreciate the feedback and your support

[@yj9032]

You are an excellent educator

[@RyanOConnellCFA]

Thank you, I really appreciate that!

[@b0ngitnator387]

Thx bryan. Have my binomial option pricing in my ca final (india) strategic financial management paper. This was definitely very helpful for me to understand.

[@RyanOConnellCFA]

I'm really glad you found it useful! Best of luck on your test, I've heard the CA can be brutal

[@b0ngitnator387]

@@RyanOConnellCFA hi Ryan, binomial and risk neutral theorem questions came in the exam. It was asking how to price the call thru both and what is the difference between them. I just remembered your explanation about how the binomial theorem works and could answer the same. Thanks for the help.

[@RyanOConnellCFA]

@@b0ngitnator387 My pleasure, and I'm really glad to hear that my explanation was able to help you on test day! Let me know if you end up passing 🥳

[@CharlesAsare-nj9qu]

Clear understanding i am in UCC level 400 , good

[@RyanOConnellCFA]

Great to hear!

[@minasalahshoury8426]

Thank you so much for making it so easy to understand🙏💐

[@kamosmash]

Great explanation

[@lyntonbr]

Thanks for the explanation... You showed the calculation taking 1 year period, Do we use the same formulas considering 1 day period? Its the difference only in the value of the down and up factors?

[@RyanOConnellCFA]

My pleasure! Yes, the same formulas used in the 1-step binomial option model for a one-year period can be applied to a one-day period, with adjustments to the up and down factors to reflect the shorter time frame. The key difference lies in recalculating these factors and the risk-free rate to match the daily timeframe, which often results in smaller magnitudes for the up and down movements compared to annual calculations.

[@globetrotterbites]

thanks so much! Do you maybe have videos on both American and European options with Dividend and non dividend paying stocks?

[@victoricus1]

Ryan, thank you for this wonderful video! I would like to clarify the following: How would one estimate 'u' and 'd' in real life? I understand it's outside of the scope of the video, but maybe you could point me in the right direction (CFA learning statement or something more intuitive). What software one would use to estimate the value of options using binomial models - python based software maybe?

[@RyanOConnellCFA]

Absolutely, I'm happy to point you in the right direction! To estimate the 'u' and 'd', you can use historical volatility or implied volatility derived from market data. Using historical data of the underlying asset, you can calculate the volatility of the asset's returns. This volatility can then be used to derive 'u' and 'd', often using formulas such as: T = expiration time n = height of the binomial tree time step size = T / n; u = exp(sigma * volatility(time step size)); d = 1/u As for software to estimate the value of options using binomial models, you can definitively use Python. I think deriving the up factor and down factor are outside the scope of the CFA curriculum

[@victoricus1]

@@RyanOConnellCFA guess i can put binomial trees on my resume as a separate skill) love how every topic has true depth to it, convoluted as hell...

[@RyanOConnellCFA]

@@victoricus1 Haha that is what I love about this stuff though. You can always dig a little bit deeper into a topic and learn more. It's really hard to cover everything in a short video

[@victoricus1]

Also, why wouldn't anyone be able to build a riskless portfolio, by using short PUT options? I dont quite get the intuition behind it...although i kinda get that one somehow manages market exposure by selling 'buy options'. Does it have anything to do with the concepts of arbitrage and replication (which I too do not really understand)?

[@RyanOConnellCFA]

The whole idea here is based on the concept of arbitrage. Most concepts in derivative pricing can usually come down to the concept of arbitrage. If there is an imbalance between the price of this option, the underlying stock, and the risk free rate, I can make risk free profit through a combination of trades. The idea of the riskless portfolio is a way to price the derivative in an arbitrage free way

[@victoricus1]

@@RyanOConnellCFA thank you! later that day i watched a couple more videos on analyst prep, kinda makes it more clear, but i think understanding comes with practice)

[@RyanOConnellCFA]

@@victoricus1 Analyst prep has some good in depth videos too! Probably the best way to understand it would be to build out a multiple step binomial pricing model in Excel or Python

[@mile3media817]

Thanks for the video. Is there a reference text

[@RyanOConnellCFA]

Its my pleasure. I personally referenced the CFA Level 1 Fixed Income material when creating this video