=+Table 7.1 The writer’s strategy in Example 7.1.

Then the writer has a positive chance of making a profit with no risk of making a loss, i.e. there is arbitrage. The price of the option, $3, is too high though it follows from the law of large numbers.

How do we price it correctly, i.e. in an acceptable way for both writer and holder of the option? Assume the framework of the model (I) with N