QuoteOriginally posted by: jokeohspacemonkey,why (K2-K1)/K2? how did you derive this?If the stock is less than K1, then the payout of the option is zero and the stock portfolio is worth more.If the stock is worth more than K1 but less than K2, the payout is S-K1 = (1-K1/S)*S and the stock portfolio is (1-K1/K2)*S. Clearly the portfolio is worth more.If S=K2 both are worth the same. As S increases past K2, the portfolio increases but the option payout remains fixed, and so the portfolio dominates in this region as well.This is probably the lowest possible upper bound (under the given constraints, assuming no dividends), but I haven't checked to make sure.I think that this would have been a very good interview question for a front-office quant job.
Last edited by spacemonkey
on July 6th, 2006, 10:00 pm, edited 1 time in total.