Markets: A Rigorous Course

M08 · Problem 3 ★★

Strike monotonicity and convexity

For European calls on the same underlying and expiry, prove without any model that for K1<K2<K3K_1<K_2<K_3: (a) c(K1)≥c(K2)c(K_1)\ge c(K_2); (b) c(K1)−c(K2)≤e−rT(K2−K1)c(K_1)-c(K_2)\le e^{-rT}(K_2-K_1); (c) c(K2)≤λc(K1)+(1−λ)c(K3)c(K_2)\le\lambda c(K_1)+(1-\lambda)c(K_3) where λ=(K3−K2)/(K3−K1)\lambda=(K_3-K_2)/(K_3-K_1). (d) Check (a)–(c) on the Dec settlement prices 24,500 → 587.65, 24,700 → 476.90, 25,000 → 334.95.

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