Numerically illustrate the binomial pricing of an equity option using the simple 1-period payoff table using any formula to keep the pricing efforts to the simplest way focusing on the cash flow involved at the two points in time. In a simple situation where movements in the price of a stock during the life of an option are governed by the one-step binomial tree, it is possible to set up a riskless portfolio consisting of a position in the stock option and a position in the stock. Riskless portfolios must earn risk-free interest in a world without arbitrage opportunities. Use the following information of a hedger in Philadelphia investing in a Livinia Stock in the USA market. The stock currently priced at $50 has a probability to rise by 10% in one period and equally drop by 4%. Its risk-free rate is 6% p.a. (use the rate for investing and borrowing).

1. Compute the three-month call price. (2 marks)

Describe with workings the riskless position of an investor by replicating a portfolio to trade the stock and option.