Suppose that the fair price of a put option is $1.50 whereas its observed (i.e., market traded) price is considerably lower at $1.00. Obviously, this presents an arbitrage opportunity. Select the best practical answer from the followings to demonstrate how you could arbitrage from the situation.

a) Buy the put at $1.00 and then, sell the same put at $1.50

b) Buy the put at $1.00 and at the same time, sell a call (assuming it is priced fairly), buy a stock and borrow from the bank

c) Buy the put at $1.00 and at the same time, sell a call (assuming it is priced fairly), short-sell a stock and invest in the bank

d) Buy the put at $1.00 and at the same time, buy a call (assuming it is priced fairly), short-sell a stock and invest in the bank

Explain your answer.

Answer rating: 100% (QA)

The detailed answer for the above question is provided below The correct answer is c Buy the put at ... View the full answer