This is a continuation of our last discussion in some ways. In the previous discussion we covered the options used as speculating and hedging. A good and simple way to price an option is a Binomial Tree. The idea is that each branch involves a random walk. Its like flipping a coin heads or tails and the next time it all resets again to either heads or tails. The Binomial Tree and its construction can use one and two period values of those options on either stocks commodities or futures. This section includes the mechanics of pricing these binomial options. In the next module after this one we will discuss the valuation in more detail. Up to now we looked at pricing an option to other options. We now look at the pricing of an option relative to the underlying asset. There are European options which only can be exercised only at expiration and American options (most popular) that can be exercised any time up to expiration.

Question(s) of Discussion. You can discuss any ONE or more of the following.

1. What is your opinion of the Binomial Tree and as far as its relevance to valuations of options.
2. Which are more important in your opinion and why; one period and two period Binomial Trees and why.
3. Try to find and add to the discussion if you can using a real company option example of an American or European option and discuss its valuation and if you think its fairly priced and why.