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Prices of a stock are modeled using a two-period binomial tree, with each period being six months.

The continuously compounded risk free interest rate is 7 % The stock pays 2 % continuous dividend. The current stock price is 65 The volatility of the stock is 40 %. Consider an American put option on the stock expiring in a year with a strike price of $65.

What is the number of stocks in the replicating portfolio at the end of the first 6 month period if we know the stock price decreased in the first period?

I was able to calculate the option premium. The formula I've been trying to use is e^(d*h)[(Cu-Cd)/(Su-Sd)]. However, I'm unsure if I need to do anything differently given that I'm trying to replicate the portfolio at the end of the first 6 month period. Any help would be great, thanks!

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closed as off-topic by skoestlmeier, Helin, LocalVolatility, phdstudent, amdopt Oct 3 '18 at 18:16

This question appears to be off-topic. The users who voted to close gave this specific reason:

  • "Basic financial questions are off-topic as they are assumed to be common knowledge for those studying or working in the field of quantitative finance." – skoestlmeier, Helin, LocalVolatility, phdstudent, amdopt
If this question can be reworded to fit the rules in the help center, please edit the question.

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Without providing you with the full answer, here is a list of similar questions with detailed solutions, you will be able to see how this has been done and replicate it to produce the correct answer!

https://www.soa.org/files/edu/edu-2009-spring-exam-mfe-qa.pdf

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    $\begingroup$ Down-voted for being a link-only answer. $\endgroup$ – LocalVolatility Oct 30 '18 at 10:51
  • $\begingroup$ Cool!!!!!!!!!!!!!!!!!!! $\endgroup$ – user22485 Oct 30 '18 at 13:30

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