Consider a family of call options on a non-dividend-paying stock, each option being identical except for its

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Consider a family of call options on a non-dividend-paying stock, each option being identical except for its strike price. The value of the call with strike price \(K\) is denoted by \(C(K)\). Prove the following three general relations using arbitrage arguments:

(a) \(K_{2}>K_{1}\) implies \(C\left(K_{1}\right) \geq C\left(K_{2}\right)\).

(b) \(K_{2}>K_{1}\) implies \(K_{2}-K_{1} \geq C\left(K_{1}\right)-C\left(K_{2}\right)\).

(c) \(K_{3}>K_{2}>K_{1}\) implies \[
C\left(K_{2}\right) \leq\left(\frac{K_{3}-K_{2}}{K_{3}-K_{1}}\right) C\left(K_{1}\right)+\left(\frac{K_{2}-K_{1}}{K_{3}-K_{1}}\right) C\left(K_{3}\right) .
\]

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Investment Science

ISBN: 9780199740086

2nd Edition

Authors: David G. Luenberger

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