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Find arbitrage-free price of a European put option

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Reference no: EM132936287

Question - A stock currently trades at £23. The market agrees that next year the stock price will either go up by 8%, or go down by 6%. The annual risk-free rate is 2%.

REQUIRED -

(a) Use the single-period binomial option pricing model to find arbitrage-free price of a European put option on this stock with an exercise price of E=£23 and maturity of 12 months.

(b) Suppose a European call option on the same stock with the same maturity and exercise price is trading at £1.50. Are there any arbitrage opportunities? If yes, demonstrate and explain how one can profit from this possibility.

Reference no: EM132936287

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