Question

# Consider a put and a call, both on the same underlying stock that has present price...

Consider a put and a call, both on the same underlying stock that has present price of \$34. Both options have the same identical strike price of \$32 and time-to-expiration of 200 days. Assume that there are no dividends expected for the coming year on the stock, the options are all European, and the interest rate is 10%. If the put premium is \$7.00 and the call premium is \$12.00, which portfolio would yield arbitrage profits? Hint: Check your answer with an arbitrage table.

 buy the put , buy the call, sell stock, sell a bond buy the stock, buy the bond, write the put, write the call buy the call, buy a bond, write the put, sell stock buy a put, buy stock, write the call, sell bond no arbitrage is available for these asset prices

For call option:

Current price of stock = \$34

Call strike price = \$32

for this we wiil excercise the call option since strike price is less than current price.

Intrinsic value = \$34 - \$32 = 2

For put option

Current price of stock = \$34

Put strike price = \$32

for this we wiil not excercise the call option since strike price is less than current price.

Intrinsic value = 0

So we will write the put option.

Hence,

Strategy is Buy the call,Buy a bond,Write the put,sell stock to maximize portfolio profits.

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