You want to buy a stock that is currently selling for $65. You forecast that in one year, the stock’s price will be either $100 or $24, with equal probabilities. There is a one-year call option on the stock available with an exercise price of $80. You are able to borrow at a rate of 6.50%. You would like to hedge your stock position using the call option.
a. What will be the call’s value if the stock price is $100 in one year? What will be the call’s value if the stock price is $24 in one year?
b. Assume that you can purchase fractional shares of stock. How many shares of stock would you buy?