Suppose European call and put options on St Barbara Ltd are selling for $0.35 and $0.24, respectively. Both options are struck at $4.85 and mature in nine months. The current stock price of St Barbara Ltd is $3.84 and the risk-free rate is 3.2% p.a. Is there an arbitrage opportunity in this market? Indicate what strategy you would implement in taking advantage of any arbitrage opportunity and the profit you would earn from your strategy (Note: You are required to outline the initial and terminal values of your strategy).

Answer rating: 100% (QA)

To determine if there is an arbitrage opportunity in this market we need to compare the prices of the call and put options to their theoretical values based on the underlying stock price strike price ... View the full answer