Replication Pricing of a Call Option with a One-Step Binomial Tree

We've currently seen two methods for pricing a call option with a one-step binomial tree in our articles on hedging and risk neutral pricing. The third method is that of replication. The basic approach towards pricing the option via replication is to determine the price of other market instruments that can guarantee to replicate the option in all possible states. We have already shown that if an option is worth as much as a portfolio of other instruments, in the future, for all possible states, then the portfolio of these instruments and the option must have equal value today, otherwise there is an arbitrage opportunity.

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