Binomial Tree Option Pricing › Key Parameters
Michael BrenndoerferDecember 1, 20251 min read
Quantitative FinanceAll chapters Part 6 of 15Numerical Methods for Derivative Pricing
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The key parameters for the Binomial Tree model are:
- S0: Current stock price. The starting node of the tree.
- K: Strike price. Used to calculate option payoffs at terminal nodes and exercise values for American options.
- T: Time to expiration in years. Determines the total duration covered by the tree.
- r: Risk-free interest rate (annualized). Used for discounting and calculating the risk-neutral probability.
- σ: Volatility (annualized). Determines the magnitude of up and down moves ( and ).
- N: Number of time steps. Controls the granularity of the tree; higher improves accuracy but increases computational cost.
- option_type: 'call' or 'put'. Determines the payoff structure.
- american: Boolean flag. If True, allows for early exercise checks at each node.