ABC common stock trades at a market price of $100. There are traded European and American put
Question:
ABC common stock trades at a market price of $100.
There are traded European and American put and call options on ABC common stock with times to expiration of 1 year and exercise prices ranging from $80 to $120 in steps of $10.
The risk free rate is 5% continuously compounded.
Consider the following statements.
Statement I. If the market price of a European put option on ABC common stock with an exercise price of $110 is lower than its lower bound, a riskless arbitrage would involve buying the option, short-selling the stock and investing $104.64 in the risk free asset.
Statement II. Using the put-call parity relationship, a long position in the risk free asset with a face value of $100 and a time to maturity of 1 year can be created by buying ABC common stock, buying a European put on the stock and writing a European call on the stock with exercise prices of $100 and times to expiration of 1 year.
Which of the following is correct?
a. Statement I is incorrect, Statement II is correct.
b. Statements I and II are correct.
c. Statement I is correct, Statement II is incorrect.
d. Statements I and II are incorrect.
Expert Answer:
