Option markets

Your client holds shares of Apple Inc. (AAPL) in his portfolio. The current price of one Apple share is $280. The client has specified that he wishes to sell his investment in Apple if the share price drops below $260 over the next two years. You have decided to advice your client to take advantage of the option market.a. You want to propose a protective put strategy to your client. Determine the price of a 2-year European put option on Apple stock using a 2-step binomial pricing model (i.e. one step is equal to 1 year). Assume that the volatility of Apple stock is 30% and that the annual risk-free rate is 1%. Both the volatility and the risk-free rate are constant through time. The strike price is $260.(10 marks)

b. Use the put-call parity relationship to estimate the value of a 2-year European call option on Apple stock at the same strike price of $260. You check the option market and observe that the same call option trades at $66. If an arbitrage opportunity exists, what strategy would you recommend to your client?(15 marks)