Binomial Method in Bermudan Option

Abstract

The Bermudan option allows the contract holders to make and buy a hybrid contract between American and European options. Bermudan option contract can be executed at certain times until the due of the contract. The purpose of this research is to determine the price of the Bermudan option using the binomial method, and then to compare the binomial method result of n steps with the market option price. In determining stock prices at each point, there will be two branches of the binomial method: up and down branches. These branches represent the movement of stock prices in the market. The result shows the price of Bermudan option is convergent at a certain value when the binomial procedure is enlarged. The comparison of the Bermudan option price using a binomial method to the market price shows that the price of Bermudan option is an approach to the market price in certain conditions. Empirically, the price of Bermudan call option is in approach to the market option price or has a minimum error when the exercise price is below the current stock price. The price of Bermudan put option empirically is in approach to the market option price or having a minimum error when the exercise price is above the current stock price.