When using the binomial pricing model to price an option, the volatility of the value of the underlying asset is represented by the difference between the two possible future values of the underlying asset.

Question

Quizplus · Accepted Answer

In the binomial pricing model, volatility is represented by the standard deviation of possible future values of the underlying asset, not by the difference between the two possible future values. The difference between the two possible future values is the up-state and down-state, which are used to calculate the probability of the stock moving up or down.

When Using the Binomial Pricing Model to Price an Option