Question 4

A 6-month European put option on a dividend-paying stock is currently selling for $2. The stock price is $95, the strike price is $100, and the interest rate is 5% per annum. A dividend of $0.3 is anticipated to pay in 8 months.

(a) Is the boundary condition violated? Explain your answer. (3 marks)

(b) Verify your trading positions taken at each point in time for the arbitrage opportunity (6 marks)

(c) What is the arbitrage strategy based on put-call parity if a European call with the identical strike price and expiry, trading at $2 is observed? (11 marks)