In a one period binomial tree option pricing model, if a European put option is

Question

In a one period binomial tree option pricing model, if a European put option is currently priced above its theoretical value according to the binomial pricing model, the trading strategy to realize an arbitrage profit from a delta neutral portfolio is to

short the put at its current price, take a short position in the underlying stock proportional to the delta of the put option and borrow a loan at the risk-free interest rate.

purchase the put at its current price, take a short position in the underlying stock proportional to the delta of the put option and invest the proceeds in bonds that earns the risk-free interest rate.

purchase the put at its current price, take a long position in the underlying stock proportional to the delta of the put option and to finance purchase with borrowed loan at the risk-free interest rate.

short the put at its current price, take a short position in the underlying stock proportional to the delta of the put option and invest in the risk-free bonds.

short the put at its current price, take a short position in the underlying stock proportional to the delta of the put option and borrow a loan at the risk-free interest rate.

purchase the put at its current price, take a short position in the underlying stock proportional to the delta of the put option and invest the proceeds in bonds that earns the risk-free interest rate.

purchase the put at its current price, take a long position in the underlying stock proportional to the delta of the put option and to finance purchase with borrowed loan at the risk-free interest rate.

short the put at its current price, take a short position in the underlying stock proportional to the delta of the put option and invest in the risk-free bonds.

Explanation / Answer

Option D is correct

In a one period binomial tree option pricing model, if a European put option is currently priced above its theoretical value according to the binomial pricing model, the trading strategy to realize an arbitrage profit from a delta neutral portfolio is to

short the put at its current price, take a short position in the underlying stock proportional to the delta of the put option and invest in the risk-free bonds

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