The argument is wrong, or at least, incomplete. Another possibility is: It's possible to create a simulated world, but it would be much smaller than the world

The argument is wrong, or at least, incomplete. Another possibility is: It's possible to create a simulated world, but it would be much smaller than the world we live in, hence our world is probably not simulated. On the other hand, jail inmates and astronauts in the International Space Station will (eventually) reasonably be able to consider option (3).