Convexity of European Call with respect to Strike:

7. (12 points) (Convexity of European Call with respect to Strike) From Section 1 of Lesson 10, we know that if K1 >EC(K1) + (1-1)EC(K3), we have an arbitrage opportunity. Mandatory Requirement: (1) You will create a portfolio that is self- funding at t = 0, and then (2) You will show that under all possible values of ST (i.e. asset-price at expiration t = T) you will not be revenue negative. (b) (4 points) Recall that in Section 1 of Lesson 11, you were told that the European Call price has to be convex with respect to the Strike. Suppose we had three strikes: K1 = $50, K2 =$55, and K3 =$65, EC(K1) =$16, and EC(K3) =$1. Present a cogent argument (No Hand-waving, Please!) that shows 1