Two-State Option Pricing Although the above example considers only four periods of time, one can lways choose an interval of time to recogmize price changes that more realistically tures expected stock price behavior. In Section Iv we demonstrate the sensitivity of option prices to the choice of the time differencing interval under the assumption that H and h" are chosen to hold the mean and variance of the distribution of stock price changes constant over the life of the option. In the Appendix, a generalized formula for the multiperiod case is derived for the situation where R, H and H- are constant. This formula is extended under the assumption that the two-state process evolves over an infinitesimally small interval of time u, Operationalizing the TSOPM In the TSoPM, the only parameters describing the probability distribution of returns of the underlying stock are the magnitudes of the holding period return, H and H. Although our examples assume that H+ and H remain constant l8.71 24.6 37,89 9.24 37.89 18.71 0 Figure 2. Price Path of European Call Option