How Does the Binomial Model Approach the Problem of Valuing the Early Exercise Feature?
The Binomial Option Pricing Model models the underlying asset's price movement as a series of discrete up or down steps over time. At each step (node) in the price tree, the model explicitly checks whether exercising the American option early yields a higher value than holding it.
This decision-making process at every node is what allows the model to correctly value the early exercise feature.
Glossar
Binomial Model
Model ⎊ The binomial model, within the context of cryptocurrency derivatives and options trading, represents a discrete-time model for simulating the evolution of an asset's price.
Early Exercise
Trigger ⎊ Early exercise, within cryptocurrency options and financial derivatives, denotes the right ⎊ but not the obligation ⎊ of the option holder to realize the intrinsic value of the contract prior to its scheduled expiration date.
Binomial Option Pricing Model
Structure ⎊ The Binomial Option Pricing Model represents a discrete-time framework where the underlying asset price can only move to one of two possible values at each successive time step, either up or down by a specific factor.