Hi im trying to price a barrier call option using a non recombining 4 step tree.S=100, k=99, r=4%,volatility=30%, u=1.090463, d=0.917042, e(-rt)=.996672, t=0.3333i am unsure if i am valueing this properly.my understanding is that i just fill out the 4step non recombing tree, then any values over the barrier of 125=0. Then i just calculated the payoffs in the usual way and value back using q=.497616.Is this right? My answer was 4.018751.i also tried to value it using monte carlo simulation using 100 values. do i just look down through my 100 stock prices and any values over 125 become 0, and calculate the payoffs and proceed as normal. is this right.id really appreciate any help or insight. ive being looking on the net and in books but i can`t get any good example that would show me if i am going wrong.

could somebody even let me know is this the right method. Why use the non recombining tree?

You haven't given us enough information to tell you if it is right, but the basic approach is good.I think this is an up-and-out call with a strike of $100 and a knock-out of $125. It has four months to expiry and the current underlying price is $100. The volatility is 30% and risk-free rate is 4%, both stated annually, and you want to price it with four steps. Is this all correct?Four steps will understate the probability of knock out significantly.

yeah thats exactly right, sorry should have been a wee bit more specific. Is my monte carlo technique right.

The technique seems right, but I can't match your numbers. I get a slightly lower value on the option.You have to use a non-recombining tree because the path matters. If you get three ups and one down, you'll be knocked out if the three ups come first, but not otherwise.

Thanks a million for your help i actually understand it now.