Referring to Exercises 11 and 12, show that Exercises 11 and 12 A straddle is a portfolio with long positions in a European call and put with the same strike price, maturity, and underlying. The...

Referring to Exercises 11 and 12, show that

Exercises 11 and 12

A straddle is a portfolio with long positions in a European call and put with the same strike price, maturity, and underlying. The straddle is seen to benefit from a movement in either direction away from the strike price. Show that the payoff of a straddle is |ST − K| and construct the payoff diagram.

Consider two European put options with the same underlying and same maturity T, one with price P’ and strike price K, the other with price P’₀
and strike price K’ > K. Give a careful arbitrage argument to show that