Call is underpriced

# Call is underpriced - for European options, consider the...

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Call is underpriced 1 Today ST < 18 ST > 18 Buy call -3 - ST − 18 Sell stock +20 -ST -ST Buy bond -17 18.79 18.79 Total 0 18.79 - ST .79

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Puts: An Arbitrage Opportunity? Suppose that p = 1 S 0 = 37 T = 0.5 r =5% K = 40 D = 0 Is there an arbitrage opportunity? Upper bound OK (40e-.05(.5) > 1). 1 ?≥ 40e-.05(.5) - 37 = 2.01 2
Put is underpriced 3 Today ST < 40 ST > 40 Buy put -1 40 - ST - Sell bond +38 -38.96 -38.96 Buy stock -37 ST ST Total 0 1.04 ST – 38.96

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Put-Call Parity; No Dividends To see how the put-call parity relationship has to hold

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Unformatted text preview: for European options, consider the following strategy. • If the cash flow in the future is zero with certainty, what should the cost today be? 4 Put-call parity 5 Today ST < K ST > K Sell call +c-K - ST Buy put-p K - ST-Buy stock-S0 ST ST Borrow (sell bond) Ke-rT-K-K Total ? The Put-Call Parity Result c- p- S 0 + Ke –rT = 0 or c = p + S 0 -Ke –rT 6...
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## This note was uploaded on 01/19/2012 for the course FIN 4520 taught by Professor Lucyackert during the Spring '12 term at Kennesaw.

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Call is underpriced - for European options, consider the...

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