3 Question 3 . For each case below, you are the trader on the opposite side of t

Question

3 Question 3 . For each case below, you are the trader on the opposite side of the trade with me at time to0) . For each case below, state the trade you will perform with me at time to0). . For each case, you must explain the reason for your trading decision . In all cases, both you and I begin with a portfolio of zero (no cash, no stock, options, etc.) 1. Money required to buy things must be borrowed from me. Interest must be paid on the loan 2. Money received by selling things is loaned to me. I will pay interest on the savings 3. The borrow and lend interest rates are equal. Both are equal to the risk-free rate 4. There is no limit on the quantity to buy or sell anything, including short selling of stock In all the cases below: 1. The current value of the stock price is So = 100. 2. The stock does not pay dividends 3. For questions involving a stock index, the current value of the index is 1000 points. 4. The stock index has a continuous dividend yield of 1.5%. 5, The interest rate is 5% (borrow and lend rates are equal). 6. All the options have the same expiration time of 1 year.

Explanation / Answer

As per put call parity, C-P-Se^(-qt)=-Xe^(-rt)

So, C-P-F=-Xe^(-rt)+Se^(-qt)-F=-105e^(-0.05*1)+100e^(-0.015*1)-105=-106.368

But as the portfolio is trading at a price of 1, which is more than the value it should have of -106.368.

I would go short on the portfolio because it is overvalued

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