Explain why a call option is equivalent to underlying stock

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1. Explain why a call option with zero exercise price is equivalent to the underlying stock, assuming no dividends on the stock during the life of the option.

2. Suppose someone offers you the following gamble: You pay $7 and toss a coin. If the coin comes up heads, he pays you $10, and if tails comes up, he pays you $5. You in turn get the idea of of- fering another person a coin toss in which he pays you $7 and tosses another coin. You tell him that if heads comes up, you will pay him $9 and if tails comes up, you will pay him $5. You think you see an opportunity to earn an arbitrage profit by engaging in both transactions at the same time. Why is this not an arbitrage opportunity and how could you make it one, assuming you could get two people to engage in these gambles?

Reference no: EM13926061

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