Question 4

a) A company had issued both European calls and puts on its own stock. Both options have a strike price of $25 and an expiration date in 9 months. The call option sells for $2.50 and the put has a premium of $2. The risk-free rate is 9.5% per annum (continuously compounded), and the current stock price is $22. Outline the procedure for a trader to exploit any arbitrage opportunity that is present.

b) Using the data from Part A, does the arbitrage still exist if the stock pays out a dividend of $0.8 in 2 months time.