Down Transition Probability

DEFINITION of 'Down Transition Probability'

The probability that an asset's value will decline in one period's time within the context of an option pricing model. The option pricing models using a down transition probability are both the binomial and trinomial option pricing models.

BREAKING DOWN 'Down Transition Probability'

In a binomial option pricing model, the probability that an option's underlying asset declines in value over a time step may be denoted by 1-Qu, where Qu represents the probability that the option's underlying asset will increase over the next time step in decimal form.

Under the trinomial model, the probability of a down transition is equal to the probability of an upward transition or an equal transition over the next time step not happening. If we denote Qu as the probability of the underlying asset increasing in value over the next time step, Qd as the probability the value of the underlying asset will decrease over the next time step, then the probability that the underlying asset's value stays the same is 1-Qu-Qd.

RELATED TERMS
  1. Derivative

    A security with a price that is dependent upon or derived from ...
  2. Trinomial Option Pricing Model

    An option pricing model incorporating three possible values that ...
  3. Option

    A financial derivative that represents a contract sold by one ...
  4. Embedded Option

    A provision in a security that is an inseparable part of the ...
  5. Intrinsic Value

    Intrinsic value is the actual value of a company or an asset ...
  6. Binomial Option Pricing Model

    An options valuation method developed by Cox, et al, in 1979. ...
Related Articles
  1. Options & Futures

    Reducing Risk With Options

    If you want to use leverage to your advantage, you must know how many contracts to buy.
  2. Fundamental Analysis

    Find The Right Fit With Probability Distributions

    Discover a few of the most popular probability distributions and how to calculate them.
  3. Options & Futures

    Options Trading With The Iron Condor

    This options strategy allows your profits to soar in a sideways market.
  4. Options & Futures

    Using Options Instead Of Equity

    Learn how to multiply returns and diversify risk by buying options instead of stock.
  5. Options & Futures

    What Does Quadruple Witching Mean?

    In a financial context, quadruple witching refers to the day on which contracts for stock index futures, index options, and single stock futures expire.
  6. Fundamental Analysis

    5 Basic Financial Ratios And What They Reveal

    Understanding financial ratios can help investors pick strong stocks and build wealth. Here are five to know.
  7. Options & Futures

    4 Equity Derivatives And How They Work

    Equity derivatives offer retail investors opportunities to benefit from an underlying security without owning the security itself.
  8. Investing

    What Investors Need to Know About Returns in 2016

    Last year wasn’t a great one for investors seeking solid returns, so here are three things we believe all investors need to know about returns in 2016.
  9. Options & Futures

    Five Advantages of Futures Over Options

    Futures have a number of advantages over options such as fixed upfront trading costs, lack of time decay and liquidity.
  10. Term

    What is Pegging?

    Pegging refers to the practice of fixing one country's currency to that of another country. It also describes a practice in which investors avoid purchasing security shares underlying a put option.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is finance?

    "Finance" is a broad term that describes two related activities: the study of how money is managed and the actual process ... Read Full Answer >>
  3. What is after-hours trading? Am I able to trade at this time?

    After-hours trading (AHT) refers to the buying and selling of securities on major exchanges outside of specified regular ... Read Full Answer >>
  4. What is the difference between positive and normative economics?

    Positive economics is objective and fact based, while normative economics is subjective and value based. Positive economic ... Read Full Answer >>
  5. Do plane tickets get cheaper closer to the date of departure?

    The price of flights usually increases one month prior to the date of departure. Flights are usually cheapest between three ... Read Full Answer >>
  6. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
Hot Definitions
  1. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  2. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  3. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  4. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  5. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center