The binomial tree method was proposed by Cox, Ross, and Robinstein in 1979. Because of this, it is also called the CRR method. Based on the CRR method, we have the following two-step approach. First, we draw a tree, such as the following one-step tree. Assume that our current stock value is S. Then, there are two outcomes of Su
and Sd
, where u>1 and d<1, see the following code:
import matplotlib.pyplot as plt plt.xlim(0,1) plt.figtext(0.18,0.5,'S') plt.figtext(0.6,0.5+0.25,'Su') plt.figtext(0.6,0.5-0.25,'Sd') plt.annotate('',xy=(0.6,0.5+0.25), xytext=(0.1,0.5), arrowprops=dict(facecolor='b',shrink=0.01)) plt.annotate('',xy=(0.6,0.5-0.25), xytext=(0.1,0.5), arrowprops=dict(facecolor='b',shrink=0.01)) plt.axis('off') plt.show()
The graph is shown here:
Obviously, the simplest tree is a one-step tree. Assume that today's price is $10, the exercise price is $11, and a call option will mature in six months. In addition, assume that we know that...