Binomial Options Pricing Model Explained

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In this video, we'll explore the Binomial Options Pricing Model. This is a very simple model that demonstrates the basics behind derivatives pricing.

It requires only some basic arithmetic - there is absolutely no stochastic calculus or anything complicated like that.

But at the same time, it clearly demonstrates many of the fundamental concepts within quantitative finance, and it can even be used to derive the Black-Scholes formula.

In this video, I’ll present the basics behind the model and we’ll use it to price an actual call option.

00:00 Introduction to Binomial Model
01:33 Constructing a Binomial Tree
06:39 Creating a Hedged Portfolio
10:59 Comparison with Real-life Probabilities
15:06 Conclusion

If you have any questions or suggestions, feel free to let me know. Thank you for watching!

[PerfilievFinancialTraining]

Hello friends! Thank you so much for watching! I’ve only recently started on YouTube, and this is one of my first videos. I really hope you’ll find it interesting and somewhat entertaining. Please, please do subscribe to the channel - at this early stage, your support has a HUGE impact, and absolutely every person counts. I am doing this full-time now, and if you want to see how it goes, it would be great to have you on board! As always, feel free to reach out for any feedback, questions and suggestions. You can ping me on Twitter or via email in the channel description. Thank you for your help and support!

[annieyang]

The most understandable content of this topic in just 15min after viewing so many similar. I saw most of your video was published 2 yrs ago and saw you started to publish new video lately, keep up working on it you are great! Have subscribed to your channel and looking forward more great stuff!

[harshvardhanranvirsingh]

Perfect Timing! I was actually reading the Risk Neutral Valuation in a 2-period binomial model! Once again great video! Looking more like these!

[riccardoformenti]

Keep up this math inclined videos, the best content you’ve published by far

[chamanthawickramarathne]

Actually, you explain everything in an easy-to-understand way. Keep it up.👍

[Leshic]

Excellent.. Wow..
Outstanding to have somebody of your experience, sharing options and trading from this perspective.
Thank you.
(here after seeing your interview a week ago)

By the way, I love how you presented it with the phone call. Excellent.
I had to watch it a 2nd time and frequently skipped back to better grasp points. (our minds often wander when listening...)

[kevw]

This was such a great clear explanation and your passion for teaching is so apparent. You make an amazing teacher!

[tanchienhao]

Best explanation on options pricing! Especially the part where you emphasise that the probability doesn’t matter, we are trading volatility not the stock!

[jongxina]

Really good video! Especially for a beginner like me. Thanks!

[alaataktokani]

i really really liked your expalnation. it is funny, enjoyable, simple and informative. the skitch in between is a great addition lol

[Revelcember]

Back then I was taught some arbitrary method to derive P and 1-p and determine the option price in Binomial Model. Although the mentioned method was easy, it lacked logic and therefore was forgettable.
You explained this method very Logically and succinctly. Now I can’t forget the derivation, even if I want to.
Thanks for the video😁

[kenmayer]

Great video. Straight to the point. Thank you.

[christopherrose]

Great video! thank you for a practical example

Such amazing content from a brand new channel.

[alilawati]

You are gifted! I was struggling to understand Shreve’s book. Your explanation is awesome. Now what about including interest rate in the model.

[nicolumps]

This is the clearest explanation I have ever seen, thank you!

[dianaluna]

That was sooo good. Super clear and lovely to watch. Thank youuuu

[BayiLi-qkrf]

Wow quite clear! Touched the subscription button after finishing this video🥰

[alexanderlapanowski]

I really appreciate this video. I worked through all of Shreeve Volume 1, and a part of Volume 2, and I was a bit worried that the Binomial Asset Pricing model was too easy or simple to be used in practice. I'm glad that some experienced quants/strats think that it's worthwhile.

[dinkysniff]

This is a really cool video and a nice explainer on the binomial model.

If anyone watching this is confused how Δ was calculated as 0.25 it might be helpful to have a further explanation because it assumes the viewer understands how to simplify the equation - in that case then it might be helpful to understand the steps;

It's explained that it's needed to find the value of Δ that makes the portfolio riskless. The portfolio consists of a long position in Δ shares and a short position in one call option.

We can see in the first step it's demonstrated that 102Δ -1 = 98Δ (you can also express as; 102Δ - 98Δ = 1)

You can simplify this equation to 4Δ = 1 (because difference between 102 & 98 is 4)

Finally, you can solve for Δ by dividing both sides of the simplified equation by 4, which gives;

Δ = 1/4 = 0.25

[hellodre]

Just listened to you on the "Confessions of a market maker" Podcast! I had your video thumb nail pop up several times of the big trade and the iceberg, so now I know who you are! I just hit your sub button,
So I'll be watching more of your vids! Btw, I have been steadily investing little by little since 2018, and started to trade forex a year ago. Keep up the great work!