Suppose today is 2nd August 2021, when the Afterpay share (APT.AX) is priced at $114.8. Consider an Afterpay option that expires on 18th November 2021, with a strike price of $120. Assume no dividends are paid on this stock. The annual historical standard deviation of Afterpay stocks is 51.27%. The risk-free rate is 0.153% with annual compounding. Ignore transaction costs (e.g. bid-ask spread).

c) Suppose that you observe that the market option prices of European call and put on this stock are currently $12.5 and $18.7, respectively. Is there an arbitrage opportunity? If you see the arbitrage opportunity, construct a strategy that leads to inevitable gain and no loss. (Construct a table showing the cashflows at initiation and expiration to demonstrate that your strategy is correct). Note part c) is independent of part b).

d) Now, you wish to connect the Binomial model to the continuous-time equivalent provided by the Black-Scholes-Merton model. The continuously compounded equivalent of 0.153% is 0.1529%. Calculate the theoretical option price of November European call and put using the BSM model. Show the formulas and calculations.

f) What are the advantages and disadvantages of a binomial option pricing model relative to BSM model?