The Impact of Trading Restrictions on the Profitability of Arbitrage Exploitation

The paper presents a favorable trading environment for the binomial option pricing model, which allows to study optimal trading strategies, and incorporates the core feature that all traders with an increasing utility for money value the option with its arbitrage free price. We study three trading restrictions, but only under the bankruptcy restriction, the exploitation of arbitrage is profitable for all traders which prefer more money to less. Under the other restrictions arbitrage possibilities may persist. The results are of special interest for questions of experimental design and for institutions which aim to impose loss controlling restrictions which conserve the profitability of arbitrage exploitation. In an option market the potential losses of traders can be controlled by the introduction of trading restrictions.