Pricing Options Using Trinomial Lattice Method

Abstract

How much to spend on option contract is the main problem at the task in pricing options. This become more complex when it comes to the case of projecting the future possible price of the option. This is attainable if one knows the probabilities of prices increasing, remaining the same or decreasing.Every investor wish to make profit on whatever amount the put in the stock exchange and thus the need of a good formula that give a very close solutions to the market prices. This project aims at introducing the concept of pricing of options by using one of the numerical methods. In particular, we focus on the pricing of a European put option which lead us to having American put option curve using Trinomial lattice model. In Trinomial method, the concept of a random walk is used to in the simulation of the path followed by the underlying stock price. The explicit price of the European put option is know, thus we will at the end of the exercise compare the numerical prices obtained using Trinomial to Binomial and Black-Scholes formula.