The last price of Wells Fargo (Ticker: WFC) on Thursday, 10/26/17, was $55.62. Options with expiration 11/17/17 had following last prices: Options with expiration 11/17/17 had following last prices:
call-strike-put
1.11-55-0.78
0.85-55.5-1.04
0.63-56-1.33
The spreads of the options were fairly low in the 0.04–0.06 range. The indicated price for the options is the average of bid and ask, which gives a good approximation for a realistic price. We will neglect interest rates in this problem.
(a) Compute $S_0+p-K-c$ for each of the three strike prices.
My answer:
$$0.29,0.31,0.32$$
(b) The computations in (a) show that the call-put parity seems to be violated. Explain the reason for this.
My answer: Wells Fargo is an American option. American options allow early exercise, unless, they are held until expiration. As we can see in the problem the expiration of the stock is 10/26 whereas the option expiration is 11/17. Since the expiration dates are not the same, there is opportunity for arbitrage, since the values in (a) are greater than 0, i.e. $S_0+p>K+c$.
My question: I understand that there is opportunity for arbitrage, but I don't understand how the arbitrage actually occurs. In this case, would a person 1. buy the $S_o+p$ or $K+c$ 2. which dates would they buy it and 3. when would they sell it. Also, what it means for $S_0+p$ to be greater than $K+c$ for the buyer's decision?