This paper presents and explains finite difference methods for pricing options and shows how these methods may be implemented in Excel. We cover both the explicit and the implicit finite difference methods. Each uses a numerical approximation to the partial differential equation and boundary condition to convert the differential equation to a difference equation. The difference equation can be solved using Excel and this solution is a numerical approximation to the option price. This paper explains how we obtain the difference equation from the differential equation and shows the reader how to implement and solve the difference equation using Excel.
This work is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License.
Kyng, Timothy J.; Purcal, Sachi; and Zhang, Jinhui C.
Excel implementation of finite difference methods for option pricing,
Spreadsheets in Education (eJSiE):
3, Article 2.
Available at: http://epublications.bond.edu.au/ejsie/vol9/iss3/2