Sloppy Joes (SJ) is a company that does not pay dividends. Its share price is currently $40. The riskfree rate of interest is 6% per annum continuously compounded. A European call option written on SJ has a $43 strike price and one year to expiry. The Black-Scholes model tells us that this call option should be trading at $9.25, yet we it trading in the market at $9. Similarly, there is a European put option written on SJ which also has a $43 strike price and one year to expiry. The Black-Scholes model tells us that this put option should be trading at $9.74, yet we see it trading in the market at $10.30. The mispricing of these two SJ options presents an arbitrage opportunity. 

Explain the trades that must be entered today in order to capture the arbitrage profit on offer. You must be very clear as to what each trade requires.

Answer rating: 100% (QA)

To capture the arbitrage profit opportunity presented by the mispricing of the Sloppy Joes SJ options you can enter the following trades 1 Initial Tra... View the full answer