The possible exercise point is at time 1 when the

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Unformatted text preview: ercise. One works backwards through the tree, starting at the end of each branch. At each node, one determines whether it is better to exercise the option (at that point) or keep it alive. If the former is true, one replaces the value of the option (determined by the recursive strategy) with the immediate exercise value. Hence, one effectively “trims” the tree, discarding unnecessary branches. Example Use the data about the underlying from the previous example. Find the price of a 2 period American Put option with strike price . ✟ ✟✟ ✯ ✟ ✟ ❍❍ ✟ ❍ ✟✟ ✟ ✟✟ ❍ ❍❍ ❍ ❍❍ ✟ ✟✟ ❍❍ ❍ ✟ ✟✟ ❍ ✟✟ ❥ ❍ ❍ ❍❍ ✯ ✟ ✟ ❍ ❥ ❍ ✯ ✟ ✟✟ ❍ ❍❍ ❍ ❥ ❍ We first calculate the time 1 value of the option if it is not exercised until time 2. ✟ ✟✟ ❍❍ ❍ ✟ ✟✟ ❍❍ ❍ ✯ ✟ ✟ ❍ ❥ ❍ 15.4 Adjusting for Dividends in the Binomial Model 139 If the put option is not exercised, we can find the time 0...
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This document was uploaded on 02/15/2014 for the course BEM 103 at Caltech.

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