In a one-period binomial model,assume that the current stock price is $100,and that it will rise to $110 or fall to $90 after one month.If an investment of a dollar at the risk-free rate returns $1.001668 after one month,and the 98-strike put option is trading at $2,how much arbitrage profit can you make in present value terms?
A)$1.93
B)$2.92
C)$3.93
D)$8.00

Question

Quizplus · Accepted Answer

We price the put to get
> u = 1.1
> d = 0.9
> R = 1.001668
> q = (R-d)/(u-d)
> q
[1] 0.5083403
> put = (98-90)*(1-q)/R
> put
[1] 3.926728
The arbitrage comes from selling the replicating portfolio for $3.93 and buying the put for $2 to capture a net cash inflow of $1.93.At maturity all cashflows net off and there is no net cash flow,so the amount captured at inception of $1.93 is the present value of arbitrage gain.

In a One-Period Binomial Model,assume That the Current Stock Price