Suppose you observe a European call option that is priced at less than the value Max[0, S0
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The call is underpriced so buy the call sell short the stock and buy riskfree bon...View the full answer
Introduction To Derivatives And Risk Management
ISBN: 9781305104969
10th Edition
Authors: Don M. Chance, Robert Brooks
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A call option is a type of financial contract that gives the holder the right, but not the obligation, to buy an underlying asset (such as a stock, commodity, or currency) at a specified price (called the strike price) within a specified period of time. When an investor purchases a call option, they are essentially betting that the price of the underlying asset will rise above the strike price before the option\'s expiration date. If the price of the asset does rise above the strike price, the investor can exercise the option by buying the asset at the strike price and then selling it at the higher market price, thereby earning a profit. Call options are often used as a speculative investment strategy, as they allow investors to potentially profit from the upward movement of an asset without having to actually own the asset itself. They are also commonly used as a hedging tool to protect against potential losses in a portfolio.
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