Consider a EUROPEAN PUT option and an AMERICANPUT option. Each option is on one share of Smart R Us Inc. Each option has an EXERCISE PRICE OF $120. 
The two options have one period remaining until expiration. 

The current price of Smart R Us is $100.By the end of the period the share price will either increase by 20% or decrease by 20%.The stock will not pay dividends.

The riskless interest rate over the period is 10%. 

1. 1) Calculate the current binomial price of the EUROPEAN put option.        
2. 2) Suppose that the current market price of the EUROPEAN put option is $5.00. Is there a profitable arbitrage? If yes, design the arbitrage, show that it is riskless, and calculate the profits on expiration day.                                          
3. 3) Calculate the current binomial price of the AMERICAN put option.   

Answer rating: 100% (QA)

1 To calculate the current binomial price of the European put option we need to calculate the option value at the end of the period and then work back... View the full answer