In class, we derived a relationship between European option prices, PUT-CALL PARITY, which states C=P+S-PV(E). Consider a security that pays off in terms of deviations from put-call parity. That is, the holder gets a cash payment equivalent to I C-P- S +PV(E)| (where || represents the absolute value). Assuming our no arbitrage and risk neutral pricing arguments hold true, what is the value of this security?

What is the value of an option written on a stock with infinite volatility? Hint: consider the Black-Scholes Formula.

Suppose there exist two stocks with the same price and volatility. The Black-Scholes option pricing model will give options with the same strike price written on these two stocks the same price. Can the expected returns of the two stocks, as given by the CAPM, be different?