1. On February 1st, September call option with exercise price of $55 written on
ID: 2707327 • Letter: 1
Question
1. On February 1st, September call option with exercise price of $55
written on Aztec stock is sold for $4.375 per share and September put
option with exercise price of $55 written the same stock is sold for $6
per share. At the time, T-bills coming due in September were price to
yield 12%. Aztec stock was sold for $53 per share on February 1st.
a. If the call option, Aztec stock, and T-bills are correctly
priced, what was the appropriate value of put option? (0.5
points)
b. How to take advantage of this situation? Please show
arbitrage profit using arbitrage table.
Does anybody get how to do part B?
Explanation / Answer
You need to use the put-call parity relation:
C - P = S - K exp(-r dt) where
C and P are the call and put option's value
S = share price
K = strike
r = interest rate
dt = time to maturity = 8/12 year
In this case:
4.375 - P = 53 - 55/(1+0.08)
=> P = $2.3
You could profit from the situation by doing a reverse conversion: Sell short the stock, buy the (discounted) T-Bill, buy the call, sell the put.
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