Question

A European call with strike X and maturity T is trading at c.
The underlying stock does not pay any dividend. The annual interest
rate is r_{f}. Suppose c > S – X/(1+r_{f})^T and
one call is on one share for simplicity. Then you can_____ one
call, ____one share of the stock and ____ X/(1+r_{f})^T to
form an arbitrage portfolio.

buy, sell, borrow |
||

sell, buy, lend |
||

sell, buy, borrow |
||

buy, sell, lend |

Answer #1

The correct answer is "sell, buy, borrow"

The call price should be equal to S – X/(1+r_{f})^T to
avoid arbitrage. Here "S" is the stock price and
X/(1+r_{f})^T is the present value of strike price. So as c
> S – X/(1+r_{f})^T, so Call price is overvalued, it
means it will go down. So you need to sell call.

If the call price doesn't increase then stock should increase to
tally the equation. So the stock is under-priced now, buy it. You
need to have money to enter the strategy, so borrow
X/(1+r_{f})^T.

A six-month European call option's underlying stock price is
$86, while the strike price is $80 and a dividend of $5 is expected
in two months. Assume that the risk-free interest rate is 5% per
annum with continuous compounding for all maturities.
1) What should be the lowest bound price for a six-month
European call option on a dividend-paying stock for no
arbitrage?
2) If the call option is currently selling for $2, what
arbitrage strategy should be implemented?
1)...

You want to price a European call option on stock X, which
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by 10%.
The option expires in one period, and has a strike price of $41.
The risk-free rate over the next period is 5% (you can lend and
borrow at the...

The price of a European call that expires in six months and has
a strike price of $28 is $2. The underlying stock price is $28, and
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Consider a put and a call, both on the same underlying stock
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the same identical strike price of $32 and
time-to-expiration of 200 days. Assume that there
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options are all European, and the interest rate is
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Assume that the stock price is $56, call option price is $9, the
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sell, buy, short-sell, lend
buy, sell, buy, lend
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An options exchange has a number of European call and put
options listed for trading on ENCORE stock. You have been paying
close attention to two call options on ENCORE, one with an exercise
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former is currently trading at $4.25 and the latter at $6.50. Both
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A
European call option and put option on a stock both have a strike
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identify the arbitrage oppotunity to a trader.

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Use put-call parity to explain how would you construct a
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