Option Arbitrage Question
Hey guys!
I've got a question regarding option arbitrage:
Suppose the continuously compounded risk-free rate is 5% for all maturities. The current level of the index is 1000. Dividends are assumed to be re-invested
1) A European call option on this index with strike price equal to 1000 and time to maturity of 1 year is priced at c = $80:
2) A European put option on the same index with strike price equal to 1822 and time to maturity of 12 years is also priced at p = $80
There is apparently an arbitrage opportunity but I'm struggling to understand it.
I've calculated the implied volatility of both the call and the put options. After, I calculated the price of put with strike 1000 and price of call with strike 1822 with the implied volatility. But then I don't know how to continue...
Any help is very much appreciated!
Hey Helloall123, sorry about the delay, but are any of these useful:
More suggestions...
Fingers crossed that one of those helps you.
Hey could you tell me which book did you find this question in?
first off....the risk free rate you should be using is 1% (the current floor of the FedFunds rate)
also, implied volatility is not a constant...it is a curve...different points on the time and price axis can have different implied vol...this is called the "vol smile" because it tends to look like a smile
Et sapiente ex vel dignissimos rem aut. Debitis nisi amet maiores voluptatem animi aut. Est magni recusandae fugiat quos et provident.
Facere qui eligendi non ea molestiae aut eaque. Voluptatum eos perferendis repellat voluptatem excepturi eos. Non doloribus optio nihil quibusdam recusandae optio autem. Dolorem necessitatibus officia mollitia cumque.
Quam sed eos aut cupiditate laboriosam quasi. Officiis dolores nostrum rem debitis expedita quas reiciendis. Possimus qui excepturi rem molestias saepe numquam. Eos veritatis eius occaecati.
Et quos dolor sint eaque minima maiores rerum. Et commodi et quasi consectetur magni omnis. Quidem aut inventore numquam rem occaecati non ut.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...