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Trinomial Option Pricing Model

Demarcation of ‘Trinomial Option Pricing Model’

The trinomial option pricing representative is an option pricing model incorporating three possible values that an underlying asset can be subjected to in one time period. The three possible values the underlying asset can deliver in a time period may be greater than, the same as, or less than the au fait value.

BREAKING DOWN ‘Trinomial Option Pricing Model’

Of the multifarious models for pricing options, the Black-Scholes option pricing model and the binomial choice pricing model are the most popular. The Black Scholes model, also identified as the Black-Scholes-Merton model, is a model of price variation over time of economic instruments such as stocks that can, among other things, be cast-off to determine the price of a European call option. The binomial option bounty model, which was developed in 1979, uses an iterative procedure, make allowancing for the specification of nodes, or points in time, during the time span between the valuation ancient and the option’s expiration date.

The trinomial option pricing model, submitted by Phelim Boyle in 1986, is considered to be more accurate than the binomial fashion, and will compute the same results, but in fewer steps. However, the cream never gained the popularity of the other models.

Trinomial vs. Binomial

The trinomial choice pricing model differs from the binomial option pricing display in one key aspect by incorporating another possible value in one time period. Below the binomial option pricing model, it is assumed that the value of the underlying asset liking either be greater than or less than, its current value. The trinomial paragon, on the other hand, incorporates a third possible value, which includes a zero change in value over a time period. This assumption decamps the trinomial model more relevant to real life situations, as it is attainable that the value of an underlying asset may not change over a time interval, such as a month or a year.

For exotic options, or an option which has promotes that makes it more complex than commonly traded vanilla elections such as calls and puts that trade on an exchange, the trinomial scale model is sometimes more stable and accurate.

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