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A stock price is currently $40. It is known that at the end of three months...

A stock price is currently $40. It is known that at the end of three months it will be either $42 or $38. The risk free rate is 8% per annum with continuous compounding. What is the value of a three-month European call option with a strike price of $39? In three months: S0 = $40 X = $39, r = 8% per annum with continuous compounding. Use one step binomial model to compute the call option price. In particular, show the following two steps:

1) What is the number of shares you need to buy for one call option you sell in order to form a risk less hedged position (covered call)?

2) What should be the call option price today?

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