Replicating Portfolio Approach

Current Stock Price (Rs)

Option Type
Exercise Price (Rs)
Time to expiration (yrs)
Risk-free rate (%)
Volatility per year (%)
No of steps
up-factor (u)
down-factor (d)

Replicating Portfolio
Stock price
Option payof
Number of stocks
Stock value
Borrowing/Lending
Net portfolio price/payof

100
EC
110
1
6.0%
20.0%
1
1.2214
0.8187

t=0
100.00
0.3015
30.15
-23.25
6.9026

Expiration
122.14
81.87
12.14
0.00
36.82
-24.68
12.14

24.68
-24.68
0.00

Valuation using risk neutral probabilities

Up probability
Down probability
Option value

0.6037
0.3963
6.9026

Valuation using risk averse (real world) probabilities

Expected return of stock
10%
Up probability
0.7113
Down probability
0.2887
Weight of stock in replicating portfolio
4.3678
Weight of bond in replicating portfolio
-3.3678
Expected return of option
22.40%
Expected value of option payof
8.6360
Option value
6.9026