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JD is currently trading at $62
JD is currently trading at $62.35. One-year European Call and Put options on JD with a strike price of $60 are trading at $5.35 and $1.57 respectively. The continuously compounded risk-free rate is 3.0%. You suspect the options are mispriced and would like to set up an arbitrage trading strategy to profit from the mispricing. How much money can you make per unit of trade? Assume there are no transaction costs other than the option premiums.
Expert Solution
Put Call Parity Equation
C + PV(K) = P + S
C = Call Premium = $5.35
PV(K) = Present value of strike price = 60 / e^(rt) = 60 / e^0.03 = 60 / 1.03045 = $58.23
P = Put Premium = $1.57
S = Spot Price = $62.35
Input the above values
C + PV(K) = P + S
5.35 + 58.23 = 62.35 + 1.57
63.58 = 63.92
as the both sides are not equal, the arbitrage opportunity exists
The risk free profit = difference between two sides = $63.92 - 63.58 = $0.34
How much money can you make per unit of trade?
$0.34
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