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Pricing
Variable
S0
X
T
r
D
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rT
p D Xe rT S 0
Put-Call Parity
c p = S0 Xe -rT
c p = S0 D Xe -rT
American options:
S0 - X C - P S0 - Xe -rT
S0 - D - X C - P S0 - Xe rT
Example (continue)
A four-month European call option on a dividend-paying stock is currently selling for $5. The stock price is $64, the strike
price is $60, and a dividend of $0.80 is expected in one month. The risk-free interest rate is 12% per annum for all
maturities. What opportunities are there for an arbitrageur?
Solution:
To prevent arbitrage we must have S0 c S0 D - Xe -rT
Here c=$5, S0=$64, X=$60, r=12%, T=4/12, D=0.8*exp(-0.12*1/12)=0.79
So, we have 5<64-0.79-60*exp(-0.12*4/12)=64-0.79-57.69=5.52
Example: (continue)
A European call option and put option on a stock both have a strike price of $18.75 and an expiration date in three months.
Both sell for $3. The risk-free interest rate is 10% per annum, the current stock price is $19, and a $1 dividend is
expected in one month. Identify the arbitrage opportunity open to a trader.
Solution:
To prevent arbitrage we must have c p = S0 D Xe -rT
Here c=p=$3, S0=$19, X=$18.6, r=10%, T=3/12, D=1*exp(-0.1*1/12)=0.99
So, we have 3-3>19-0.99-18.75*exp(-0.1*3/12)=19-0.79-18.29=-$0.08