A technique which is used to price options by graphically illustrating possible intrinsic values that an underlying asset (stock) may take at different nodes (time periods), and then calculating the option price starting from the end of the tree to its beginning (a technique known as backwards induction).

Though binomial trees are instrumental tools in pricing options, their model features a basic flaw due to the fact that the values of the underlying assets at a given node depend solely on the values of the two previous nodes. That is because the underlying asset can take just one of two possible values and that comes in contrast to the random walk that characterizes movements of asset prices over time.