What happens to the price of an option using a binomial option pricing model with many periods as the numbers of periods increases?
A) The model because useless for calculating the price of an option.
B) The value of a put and a call option are less divergent.
C) The put option price gets closer to zero and the call option price gets closer to infinity.
D) The option price converges towards the option price from the Black-Scholes model.
E) The time value of the option decreases exponentially with the number of periods.

Question

Quizplus · Accepted Answer

As the number of periods increases in a binomial option pricing model, the option price converges towards the option price from the Black-Scholes model, which is a continuous-time model. Therefore, D is the best choice. Option A is incorrect as the model is still useful, but just becomes more complex with more periods. Option B is incorrect as the value of a put and a call option can still be quite divergent in a binomial model with many periods. Option C is incorrect as it suggests the put option price approaches zero and the call option price approaches infinity, which is not consistent with option pricing theory. Option E is incorrect as the time value of an option does not necessarily decrease exponentially with the number of periods in a binomial model.

What Happens to the Price of an Option Using a Binomial