A stock is currently worth £50. The value of a call option on the stock with a s

Question

A stock is currently worth £50. The value of a call option on the stock with a strike price of £47.5 and maturity of 100 days is £4.38. The continuously compounded risk-free interest rate is 5% per annum. For a put option on the same stock with strike price of £47.5 and maturity of 100 days, you are quoted a price of £2.13. F) Is the quoted put premium fairly priced? Justify your answer If not, how would you construct an arbitrage portfolio to profit from the situation? Show all your calculations and assume a 360-day year A stock is currently trading at £25. Suppose that you buy a call option and a put option with strike prices £27 and £23, respectively. The options are on the same stock and mature in a year's time. This combination of options is known as a long strangle. The prices of the options are £3.506 (for the option with strike £27) and £5.435 (for the option with strike £23). G) Construct the table of net payoffs from this portfolio of options at maturity When should an investor select such a trading strategy?

Explanation / Answer

Using put-call parity

X(1+r)n+C-S0=P

Therefore price of put should be = 47.5(1.05)100/360 +4.38-50=2.52

therefor the put option is underpriced therefore you should buy put and sell call option to take advantage of arbitrage

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