So the question asks: Find the option price and the replicating strategy.

In either case the amount owed at time 1 includes interest of 7. The part you don't understand is related to forming so-called replicating portfolios.

Replication strategy of European call option - Quantitative Finance Stack Exchange

More specifically, using only the stock and a risk-less cash account, the question is 'How can one build a portfolio allowing to perfectly replicate the option's behaviour over a given time frame' here a period of the binomial tree. But we can determine them easily. This yields two equations:.

A subtle point here: In other words, you are long the option but short the replication portfolio. By posting your answer, you agree to the privacy policy and terms of service. Sign up or log in to customize your list.

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Replication strategy of European call option. So the solution is: This yields two equations: Quantuple 7, 1 6 Sign up or log in StackExchange. Sign up using Facebook.

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