Mastering Python for Finance - Second Edition

Using a binomial lattice

We will create a binomial lattice from the binomial CRR tree since at every alternate up and down nodes, the prices recombine to the same probability of ud=1. In the following diagram, S_u and S_d recombine with S_du = S_ud = S₀. The tree can now be represented as a single list:

For a N-step binomial tree, a list of size 2N +1 is required to contain the information on the underlying stock prices. For European option pricing, the odd nodes of payoffs from the list represent the option value upon maturity. The tree traverses backward to obtain the option value. For American option pricing, as the tree traverses backward, ...