Valuation Of Binary Option In Excel

Valuation of binary option in excel

Valuation of binary option in excel

Binary option pricing: simulation ingredients

The most straightforward way in pricing a binary option is done through a simulation experiment.

In many simulation exercises, the geometric Brownian motion, as shown below, can be used to model the underlying stock behaviour.

Valuation of binary option in excel

In this formula S equals the price of the stock, μ equals the stock’s return, σ equals the stock’s volatility and Δt equals 1 time step. Another possibility to value binary options is the construction of a multi-step binomial model.

In order to implement the stock price evolution in Excel this has to be restated as follows:

With an uncertainty parameter ε generated by a certain distribution, often just a normal distribution.

Binary option pricing: simulation implementation

The value of a Binary option can be calculated based on the following method:

Step 1: Determine the return μ, the volatility σ, the risk free rate r, the time horizon T and the time step Δt

Step 2: Generate using the formula a price sequence

Step 3: Calculate the payoff of the binary call and, or put and store it

Step 4: Apply step 2 and 3 N times (e.g.

Exotic options: binary (aka, digital) option (FRM T3-44)

10000)

Step 5: Calculate the average of all the stored payoffs

Step 6: Discount this value back to today