Question

Circular File stock is selling for $21 a share. You see that call options on the stock with exercise price of $14 are selling at $2. What is riskless profit you may receive? (Round your answers to the nearest whole dollar.)
	Riskless profit	$
	What will happen to the option price as investors identify this opportunity?
	Investors will drive up(Click to select)drive updrive down the call price until the profit opportunity disappears. The (Click to select)minimummaximum price of the call will be $.
b.	Now you observe that put options on Circular File with exercise price $31 are selling for $4. What is the riskless profit? (Round your answers to the nearest whole dollar.)

	Riskless profit	$
	What should the minimum price of a put be?

The minimum price of a put

$

Answer 1

In a call option payoff = stock price - exercise price = 21 - 14 = 7

Profit = Payoff - premium = 7 - 2 = 5

Riskless profit = 5

Once the arbitrage opportunity is identifieed then the demand fro the call option will increase which will increase the price of the call option till th point when there is no profit.

The minimum price of the call option will 0 and the maximum call price will be the intrinsic value of the call option ie ( Stock price - exercise price ) ie 7

Risk less profit on th eput option = ( exercise price - stock price ) - option premium

= 31 - 21 - 4 = 6

The minimum value of the put option is 0 .