CVXs stock (Chevron) is currently trading at $156. Imagine that in one year, the price of CVXs stock can increase to either $178 or decrease to $112. Assume CVX pays no dividends. The risk-free rate is 4%. Use the binomial pricing model to compute the price of a K = $160 call option that expires in one year. Interpret the replicating portfolio: what is the value of X and Y? should we buy or short shares? Should we borrow or lend at the risk-free rate?

Draw the binomial trees for the stock and the option

Compute the payoff of the option in either state of nature

Compute the values of X and Y. Interpret X and Y.

Compute the price of the option