Question 2 [21 marks] (1) European call and put prices for a stock are available as follows: Strike Price Call Price Put

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Question 2 21 Marks 1 European Call And Put Prices For A Stock Are Available As Follows Strike Price Call Price Put 1 (33.58 KiB) Viewed 37 times

Question 2 21 Marks 1 European Call And Put Prices For A Stock Are Available As Follows Strike Price Call Price Put 2 (12.16 KiB) Viewed 37 times

Question 2 [21 marks] (1) European call and put prices for a stock are available as follows: Strike Price Call Price Put Price $45 $4 $55 $7 $9 $60 $4 All six options have the same expiration date. The risk-free interest rate is zero, $12 $12 After reviewing the information above, Millie claims that one could use the fol- lowing zero-cost portfolio to obtain arbitrage profit: Short one put option with strike price 45; long 3 put options with strike price 55; lend $1; and short some number of put options with strike price 60. Is Millie correct? (Show ALL necessary working.) 17 marks] (ii) Let P() denote the time 0 price for a European put option maturing at time t and with strike price Ki = Ken. Suppose that PO P(T), where I <T. Show that this leads to an arbitrage opportunity. The underlying stock does not pay any dividends. [14 marks]
(ii) Let P(t) denote the time 0 price for a European put option maturing at time t and with strike price Ki = Kel. Suppose that P(1) P(T), where <T. Show that this leads to an arbitrage opportunity. The underlying stock does not pay any dividends. [14 marks