the price of a non-dividend-paying stock is $19 and the price of a 3-month European call option on the stock with a strike price of $20 is $1, while the 3-month European put with a strike price of $20 is sold for $3. the risk-free rate is 4% (compounded quarterly). Describe the arbitrage strategy and calculate the profit.
Kindly dont forget the second part of the question
In this case,
c = 1,
T = 0.25,
S0 = 19,
K = 20, and
r = 0.04
From put–call parity,
p = c + Ke-rt - S0
p = 1 + 20e-0.04*0.25 - 19 = 1.80
so that the European put price is $1.80.
Now, since the put price is more than the findamental price, it is overvalued.
Arbitrage strategy to be used is as below:
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