1
$\begingroup$

I have some trouble solving the following question:

We have an european call and put option (with the same maturity date $T$ en strike $E=10$). The stock price now is $S=11$ and we use a continuous compound interest of $r=0.06$. Determine, using the put-call parity, an investment strategy to accomplish a risk-free profit based on the arbitrage principle if both options have value $V=2.5$

I cannot figure out how to approach this problem. The put-call parity alone does not seem to solve this problem. Help is very much appreciated.

$\endgroup$
1
$\begingroup$

The left hand side $(C-P)$ of the put-call partity equation provides the same pay-off as the right hand side $(S-K\times e^{-rT})$. Determine (by filling in the numbers) which part of the equation is relative cheap e.g. $(C-P) < (S-K\times e^{-rT})$. If this is the case, sell the $(S-K\times e^{-rT})$ and use the funds from selling to buy $(C-P)$. The pay-off from $C-P$ can be used to settle $(S-K\times e^{-rT})$ at maturity, the profit from initial selling and buying is the profit.

$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.