Binomial Option Pricing Interview Guide
Binomial option pricing interview guide for up and down states, replication, risk-neutral probabilities, discounting, examples, and limits.
Candidates preparing for discrete option-pricing and hedging prompts.
A binomial tree uses up and down states
A binomial option model lets the underlying move up or down each step. The option is priced by working backward from future payoffs under no-arbitrage assumptions.
Replication is the intuition
In a one-step tree, you can often solve for stock and cash positions that replicate the option payoff in both states. That replication determines the option value.
Concrete example
If a call pays in the up state and zero in the down state, solve for a portfolio of underlying and cash that matches both payoffs, then price that portfolio today.
Risk-neutral probabilities simplify pricing
The same price can be expressed as discounted expected payoff under risk-neutral probabilities. Those probabilities come from no-arbitrage, not real-world forecasting.
Common mistakes
Candidates often skip discounting or confuse physical and risk-neutral probabilities. State the tree, payoff, replication, and assumptions in order.
Practice the pattern
Use the LeetQuidity curriculum and calibration to turn this topic into a focused practice plan.