Imagine you are a trader at a large investment bank and that there is a stock traded today on the stock market at a price of $100 which will be worth tomorrow either $120 or $80.

1. You have the information from a reliable source that tomorrow's price of the stock will increase to $120 with a probability of 80% and decrease to $80 with a probability of 20%. Another trader who works for a competitor is calling you and offers you to buy a put option from her on that stock for $3 maturing tomorrow with a strike price of $100.
2. What do you do? Can you make money without any capital requirement and without any risk? Provide an explanation for your answer and assume for simplicity that the risk-free interest rate r is equal to zero.

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SOLUTION As a trader at a large investment bank I have the information that the stock price will either increase to 120 or decrease to 80 tomorrow The ... View the full answer