Today’s price of a non-dividend paying stock is $60. Use a two-step tree to value a European call option on the stock with a strike price of $60 that expires in 6 months. Each step is 3 months. The risk free rate is 5% per annum with continuous compounding. Assume that the option is written on 100 shares of stock, and that u = 1.15 and d = 0.85.
1. What is the option price today?
2. How would you hedge a position where you buy the call option today?