Δ = Number of shares in replicating portfolio.
B= Dollars of borrowing in replicating portfolio.
TheobjectiveistocombineΔsharesofstockandBdollarsof
borrowingto replicate thecash flowsfrom thecallwith a
strikepriceof50.Thiscanbedoneiteratively,startingwith
the last period and working back through the binomial tree.
Step 1:Start with the end nodes and work backwards:
Thus,ifthestockpriceis$70att=1,borrowing$45and
buyingoneshareofthestockwillgivethesamecashflowsas
buyingthecall.Thevalueofthecallatt=1,ifthestockprice
is $70, is:
Considering the other leg of the binomial tree att= 1,