Down Transition Probability

AAA

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.

INVESTOPEDIA EXPLAINS '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. Trinomial Option Pricing Model

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

    A financial derivative that represents a contract sold by one ...
  3. Derivative

    A security whose price is dependent upon or derived from one ...
  4. Embedded Option

    A provision in a security that is an inseparable part of the ...
  5. Binomial Option Pricing Model

    An options valuation method developed by Cox, et al, in 1979. ...
  6. Intrinsic Value

    1. The actual value of a company or an asset based on an underlying ...
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. Economics

    Understanding Perpetuity

    Perpetuity means without end. In finance, a perpetuity is a flow of money that will be received on a regular basis without a specified ending date.
  6. Fundamental Analysis

    What is a Null Hypothesis?

    In statistics, a null hypothesis is assumed true until proven otherwise.
  7. Options & Futures

    Top Brokers Offering Tools For Covered Calls

    Here are the brokers that offer the best tools for investors and traders to write covered calls and covered puts.
  8. Economics

    Effects of OIS Discounting for Derivative Traders

    The use of OIS discounting has important implications for derivative valuations and could positively or negatively impact a trader's profit or loss.
  9. Options & Futures

    The Perks of Trading Coffee Options

    As more people begin to trade coffee, we explain how coffee options work, who uses them, what drives valuations, and the risks and rewards.
  10. Trading Strategies

    Top Day Trading Instruments

    Day trading is an intense and often appealing activity. Investopedia provides the list of top financial instruments for day trading.

You May Also Like

Hot Definitions
  1. Income Effect

    In the context of economic theory, the income effect is the change in an individual's or economy's income and how that change ...
  2. Price-To-Sales Ratio - PSR

    A valuation ratio that compares a company’s stock price to its revenues. The price-to-sales ratio is an indicator of the ...
  3. Hurdle Rate

    The minimum rate of return on a project or investment required by a manager or investor. In order to compensate for risk, ...
  4. Market Value

    The price an asset would fetch in the marketplace. Market value is also commonly used to refer to the market capitalization ...
  5. Preference Shares

    Company stock with dividends that are paid to shareholders before common stock dividends are paid out. In the event of a ...
  6. Accrued Interest

    1. A term used to describe an accrual accounting method when interest that is either payable or receivable has been recognized, ...
Trading Center