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A European call option and a put option on a stock both have a strike price of $20 and an expiration date in three months
A European call option and a put option on a stock both have a strike price of $20 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.
a. Some stocks are ‘hard to borrow’ so that put-call parity can be violated in certain situations. Please write down some reasons why a stock may be hard to borrow.
Expert Solution
There is a finite/limited and variable number of shares available for shorting. Once the number of shares available has come close to running out, a security may be on the hard-to-borrow list because it is in short supply.
Other reasons might be -
1. Unusual pricing of vertical spreads (Put spreads/ call spreads),
2. Short Squeezes
3. Financing costs imply reduced, even negative, rates for shorting
4. Nominal Put-Call Parity does not hold
5. High or increased volatility
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