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A stock has a current price of $70. A call option written on this stock has a strike price of $72 and expires in 4
A stock has a current price of $70. A call option written on this stock has a strike price of $72 and expires in 4 months' time. The riskfree rate of interest is 4% pa continuously compounded. Using a 1-step Binomial tree, this option should be valued at $7.53. Stock prices are shown in black and option prices in blue. 88.19 16.19 70 7.53 55.57 0 While the option should be trading at $7.53, you notice it is actually trading at $8.50. 0 While the option should be trading at $7.53, you notice it is actually trading at $8.50. Briefly explain the three trades that you will execute today (at Time 0) in order to capture the arbitrage profit on offer from this mispricing. You do not need to show the cashflows at Time T (4 months). I want you to clearly describe the trades that must be made today at Time 0. Also articulate the time-0 cashflow from each of these trades
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