Question

Suppose a European put price exceeds put-call parity. How could an investor profit? Assuming a one-period strategy, what are the different outcomes of your strategy?

Answer 1

Put Call Parity is

Stock + Put = Call + Present Value of Bond

The above equation shoukd always tally, else there will be arbitrage. So according to the question, the put price has increased. So what should be the outcomes and how will an investor profit

Scenario 1:

As the put price has risen, so to maintain the balance of LHS and RHS, the stock price should fall. If the stock price falls, then the investor can earn by shorting the stock.

Scenario 2:

To maintain the balance of LHS and RHS, the Call price should rise. So if the call price is expected to rise, the investors should invest in call.

Scenario 3:

To maintain the balance of LHS and RHS, the bond price should rise. So if the bond price is expected to rise, the investor should invest in the bond.