A Method for Teaching the Binomial Option Pricing Model in Investments Courses

Abstract

One of the most important concepts in modern finance in general, and in teaching an investments course in particular, is
option pricing. While the Black-Scholes model is the most well known option pricing method, we have found that the binomial
option pricing model is sometimes better for illustrating how
different inputs affect the value of the option. The binomial option pricing model provides students with an intuitive understanding of the mechanics of option pricing. The binomial option pricing model is also widely used in practice. This paper
presents an implementation of the one-period binomial model
in Excel. By using spin buttons, students can directly observe
the effects of changes in volatility, the underlying asset price,
and the risk free rate, on the price of a call option. The model
also allows students to compare prices of options with different
strike prices. In addition to calculating binomial option prices
and providing students with improved intuition, this spreadsheet provides a graphical representation of option value relative to the value of the underlying asset.