Suppose an Apple stock currently sells for $25 and a Google stock sells for $28.

Question

Suppose an Apple stock currently sells for $25 and a Google stock sells for $28. The premium of an option that permits you to give up one share of Apple, receiving one share of Google is $3.5. The premium of an option that permits you to receive one share of Apple by giving up one share of Google is $2.3. Both options will expire in 6 months and neither stock pays a dividend until then. The risk-free interest rate is 5%. Can you make arbitrage? If so, demonstrate by a transaction-cash flow table.

Explanation / Answer

Given Apple Stock Google Stock Price $25 $28 Premium $3.5 $2.3 Period 6 Month 6 Month Rate 5% 5% Arbitrage is possible since rate of premium is different

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