How Does the Binomial Option Pricing Model Handle Early Exercise?
The binomial model handles early exercise of American options by checking at every time step (node) in the tree whether the option's value if exercised immediately is greater than its continuation value (the expected value of holding the option until the next step). If the immediate exercise value is greater, the model assumes the option is exercised at that node, correctly reflecting the American-style flexibility.
Glossar
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.
Immediate Exercise Value
Value ⎊ Immediate Exercise Value is synonymous with the intrinsic value of an option, representing the profit that would be realized if the option were exercised at the current moment, calculated as the positive difference between the underlying price and the strike price for a call, or vice versa for a put.
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.