DEFINITION of 'Binomial Option Pricing Model'
An options valuation method developed by Cox, et al, in 1979. The binomial option pricing model uses an iterative procedure, allowing for the specification of nodes, or points in time, during the time span between the valuation date and the option's expiration date.
The model reduces possibilities of price changes, removes the possibility for arbitrage, assumes a perfectly efficient market, and shortens the duration of the option. Under these simplifications, it is able to provide a mathematical valuation of the option at each point in time specified.
INVESTOPEDIA EXPLAINS 'Binomial Option Pricing Model'
The binomial model takes a riskneutral approach to valuation. It assumes that underlying security prices can only either increase or decrease with time until the option expires worthless. A simplified example of a binomial tree might look something like this:
Due to its simple and iterative structure, the model presents certain unique advantages. For example, since it provides a stream of valuations for a derivative for each node in a span of time, it is useful for valuing derivatives such as American options which allow the owner to exercise the option at any point in time until expiration (unlike European options which are exercisable only at expiration). The model is also somewhat simple mathematically when compared to counterparts such as the BlackScholes model, and is therefore relatively easy to build and implement with a computer spreadsheet.

LatticeBased Model
An option pricing model that involves the construction of a binomial ... 
Option
A financial derivative that represents a contract sold by one ... 
Black Scholes Model
A model of price variation over time of financial instruments ... 
Expiration Date (Derivatives)
The last day that an options or futures contract is valid. When ... 
Efficient Market Hypothesis  EMH
An investment theory that states it is impossible to "beat the ... 
HeathJarrowMorton Model  HJM ...
A model that applies forward rates to an existing term structure ...

What is the average return on equity for a company in the electronics sector?
Two of the more common equity derivative pricing models are the BlackScholes model and the binomial option pricing model. ... Read Full Answer >> 
Why would a company issue a rights offering?
Companies most commonly issue a rights offering to raise additional capital. A company may need extra capital to meet its ... Read Full Answer >> 
What is the difference between share purchase rights and options?
There is a big difference between share purchase rights and options. With share purchase rights, the holder may or may not ... Read Full Answer >> 
What is the difference between an optionadjusted spread and a Zspread in reference ...
Unlike the Zspread calculation, the optionadjusted spread takes into account how the embedded option in a bond can change ... Read Full Answer >> 
In what ways can a sinking fund affect bond returns?
The effective yield of a bond sinking fund to an investor should not be considered similar to a bond nonsinking fund. Both ... Read Full Answer >> 
Can delta be used to calculate price volatility of an option?
The delta of an option is a component of the BlackScholes option pricing formula, which provides the implied volatility ... Read Full Answer >>

Options & Futures
Breaking Down The Binomial Model To Value An Option
Find out how to carve your way into this valuation model niche. 
Options & Futures
Getting To Know The "Greeks"
Understanding price influences on options positions requires learning about delta, theta, vega and gamma. 
Options & Futures
Options Basics Tutorial
Discover the world of options, from primary concepts to how options work and why you might use them. 
Options & Futures
Employee Stock Options (ESO)
Employee stock options are a form of equity compensation granted by companies to their employees and executives. 
Bonds & Fixed Income
Accounting and Valuing Employee Stock Options
Learn the different accounting and valuation treatments of ESOs, and discover the best ways to incorporate these techniques into your analysis of stock. 
Investing
What More Volatility Means For Momentum Stocks
One byproduct of the recent tick higher in bond yields: a meaningful rise in volatility for both stocks and bonds. 
Options & Futures
How & Why Interest Rates Affect Options
The Fed is expected to change interest rates soon. We explain how a change in interest rates impacts option valuations. 
Investing Basics
Understanding Notional Value
This term is commonly used in the options, futures and currency markets because a very small amount of invested money can control a large position. 
Options & Futures
The Risks Of Writing Covered Calls
While writing a covered call option is less risky than writing a naked call option, the strategy is not entirely riskfree. 
Options & Futures
How Low Can Oil Prices Go?
Record low oil prices are a welcome development for consumers, but oil companies are struggling with choosing market share over profitability.