We will derive a two-state put option value in this problem. Data S0 = 110; X = 120; 1 + r = 1.1. The two possibilities for ST are 140 and 100.
a. The range of S is 40 while that of P is 20 across the two states. What is the hedge ratio of the call?
b. Calculate the value of call option on the stock with an exercise price of 120. (Do not use continuous compounding to calculate the present value of X in this example, because the interest rate is quoted as an effective per-period rate.)