ExtremeCPA - Technology for Business

Tuesday, January 17, 2006

Binomial Pricing Model for Options

Hi all! I hope you all had fantastic Holidays and a wonderful New Year. As I mentioned in my previous post, I'm going to try to be better about writing more starting now and moving forward. We'll see how it goes :) The title for this post is a little misleading. I recently read an article in the JoA about how to create a binomial pricing model for options in Excel. I've recently been thinking about how technology can influence the way you solve a particular problem; furthermore, I've been thinking about how uninformed I was (an still am) in regards to technology and you never really know how much you don't know.

In reality, I'm sure quite a few of us feel that we are quite well versed insofar as technology is concerned. I myself felt this way several years ago when I began to learn VBA and Excel. I found that I could do things that many other people could not simply because I could write VBA code. I then found myself turned on my head when I found out about Python (an open source scripting language). I realized that not only was I pretty clueless, but I would have never even realized how clueless I was if I was not introduced to the language in the first place. This turned me on to looking into other technology areas that further enhanced my skills. I am not, however, quite as naive as before and I realize that I still have a *long* way to go before I would consider myself well versed in technology.

You are probably wondering, why am I writing this now? Well, just to let you know that I think you should be learning more and more each and every day. Perhaps try to tackle a new project by using VBA if possible wherever you can. There are several fantastic tutorials about VBA at places like Mr. Excel, Beyond Technology and others. Just do a Google search for VBA tutorials (or something similar) and you'll find a ton of resources. You can always write and ask me if you have help as well. I started off by talking about a binomial pricing model for options in Excel, and I'll conclude by giving you an example of something you can create using VBA once you become fairly proficient. I've tried to document the code although I'm sure there will be questions if you start reading it. Not all of the functionality from the article is included in the model (specifically, it was too time consuming trying to figure out how to include the ability to calculate an early exercise if the option reaches a certain multiple using VBA), but much of the functionality is there. Feel free to try it out and give comments ... click here to get the model.

Again, this is simply in the hopes of inspiring some of you to learn more about technology. Good luck!

14 Comments:

  • Hi Kevin,

    What simple formula can I use to figure out the share price of a start-up company. I would like to use the discounted rate cashflow model to figure out the cost per share for the IPO. If the cashflow at the end of the 1st 12 months is projected at $850,000, then what would it cost per share. Assuming the discounted rate is the prime rate, plus 4% (11.25%), and issuing 10,000 shares. Does this make sense?

    By Blogger Search Hippie, at 11:55 AM  

  • Well, it depends. If you want to assume even cash flows on a monthly basis, you could write:

    =PV(.1125/12, 12, 70,833.33)

    This indicates an 11.25% rate compounded monthly, for 12 mos, with cash flows = 850/12. If you assume a pymt at the end of 12 mos, you could write:

    =PV(.1125/12, 12, 0, 850000)

    This would imply 11.25% compounded monthly for 12 mos, with 1 final payout at 850k. If you don't want monthly compounding, simply take out the "/12" and change the 2nd number to 1 (from "12").

    Hope this helps!

    By Blogger Kevin T. Ryan, at 3:04 PM  

  • great post.

    Abby
    http://www.corporatestorefront.com

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