XYZ shares are currently trading at $23.  There are two options written on XYZ shares available in the market with the same strike of $24 and maturity of 18 months. Information regarding these two options is as follows:

       

Call options trading at $3.32.  You calculate the fair price of this call option is $3.68.

Put options trading at $3.20.  You calculate the fair price of this put option is $2.94.

 

The risk-free rate is 5% compounded continuously.

  

Prove that an arbitrage opportunity exists using put and call parity.

 

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Describe a trading strategy to exploit the above arbitrage opportunity. The table below may be useful. Strategy Cost PAYOFF ST > X ST < X Describe a trading strategy to exploit the above arbitrage opportunity. The table below may be useful. Strategy Cost PAYOFF ST > X ST < X

Answer rating: 100% (QA)

To prove that an arbitrage opportunity exists using put and call parity we can compare the cost of constructing a synthetic call option and a synthetic put option with the actual prices of the call an... View the full answer