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Practice Problems

A 1-month European put option on a non-dividend-paying stock is trading

A 1-month European put option on a non-dividend-paying stock is trading at $2.50. The option has a strike price of $50 and the underlying stock is priced at $46. The interest rate is 10% (continuously compounded). Is there an arbitrage opportunity? If yes, explain why and show the transactions you could undertake today (i.e., attempt=0) to guarantee zero payoffs today and a positive payoff in 1 month for all possible realizations of the stock price in 1 month. If no, explain why not.

Hint
Accounts & FinanceNon-dividend-paying stock refers to the stocks where a company does not make annual or quarterly cash payments to each of its shareholders. Therefore, a decision to invest in this particular type of stock requires an individual to have alternative sources of income since the only way to make money off them is by selling....

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