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Question 3 (10 marks) An options exchange has a number of European call and put options listed for trading on ENCORE stock. You have been
Question 3 (10 marks) An options exchange has a number of European call and put options listed for trading on ENCORE stock. You have been paying close attention to two call options on ENCORE, one with an exercise price of S52 and the other with an exercise price ofS50. The former is currently trading at $4.25 and the latter at S6.50. Both options have a remaining life of six months. The current price of ENCORE stock is $51 and the six-month risk free rate is 3% pa., continuously compounded Required: How would you exploit this situation to earn arbitrage profits? You should assume the arbitrageur can borrow or lend at the risk free rate, can short sell shares if necessary and does not face any transaction costs Hint: For call options with different strike prices but the same expiration date, the maximum difference between call prices is C1 - C2 K1. You are expected to employ the five-step proof method to demonstrate your arbitrage strategies. When demonstrating the arbitrage opportunity, you will need to consider different scenarios at time
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