ASM 9th ed pg. 282

[LifeIsAPoissonProcess]

Example 13B asks to calculate an option based on 3 monthly stock prices using a binomial tree. The answer says that there are 8 possibilities over 3 months. I thought 3 monthly stock prices = 4 possibilities, since it only takes 2 months to gather 3 separate prices. I think the wording in the answer and the question are referencing two different time intervals, although independently, each of the phrasings is correct. Anyone have insight to the terminology of "3 monthly prices" vs. "prices over 3 months"?

[Actuarialsuck]

Originally Posted by LifeIsAPoissonProcess

Example 13B asks to calculate an option based on 3 monthly stock prices using a binomial tree. The answer says that there are 8 possibilities over 3 months. I thought 3 monthly stock prices = 4 possibilities, since it only takes 2 months to gather 3 separate prices. I think the wording in the answer and the question are referencing two different time intervals, although independently, each of the phrasings is correct. Anyone have insight to the terminology of "3 monthly prices" vs. "prices over 3 months"?

Are you counting the initial node? You shouldn't be since that one is given (you don't need to calculate it).

[LifeIsAPoissonProcess]

Originally Posted by Actuarialsuck

Are you counting the initial node? You shouldn't be since that one is given (you don't need to calculate it).

Yes I am counting the initial node. Why does my need to calculate the stock price have anything to do with how many prices we need? If I have 3 coins, and find out one is a penny, I don't suddenly have 2 coins...

[Actuarialsuck]

Originally Posted by LifeIsAPoissonProcess

Yes I am counting the initial node. Why does my need to calculate the stock price have anything to do with how many prices we need? If I have 3 coins, and find out one is a penny, I don't suddenly have 2 coins...

Maybe it's convention but later when you get to Asian prices (or maybe this IS Asian options), you never look at

[d45]

The option says to calculate based on 3 monthly stock prices not 4, even though that could be done also.

[LifeIsAPoissonProcess]

Originally Posted by Actuarialsuck

Maybe it's convention but later when you get to Asian prices (or maybe this IS Asian options), you never look at

This is an asian option. I don't really understand where you are coming from by saying that we never look at S(0). You need S(0) to calculate the next node, otherwise u and d wouldn't help you. Without it, you just have your options in terms of the the original stock price instead of in dollars.

[Actuarialsuck]

Originally Posted by LifeIsAPoissonProcess

This is an asian option. I don't really understand where you are coming from by saying that we never look at S(0). You need S(0) to calculate the next node, otherwise u and d wouldn't help you. Without it, you just have your options in terms of the the original stock price instead of in dollars.

What I am saying is that when they ask you to calculate averages, you do not include the starting price in your averages.

[LifeIsAPoissonProcess]

Originally Posted by Actuarialsuck

What I am saying is that when they ask you to calculate averages, you do not include the starting price in your averages.

I agree with that, but there is more to an asian option than its average.