Question 4

The FBM KLCI and index options possess the following values :

FBM KLCI = 730 points

740 call = 7 points

740 put = 2 points

The spot index can be traded. The risk-free rate is 5% per annum. The options expire in 60 days.

Required:

1. Prove that there is mispricing. (2 marks)
2. Propose a suitable arbitrage strategy and calculate the arbitrage profit. (2 mark)
3. Draw a graph of arbitrage strategy and the relevant positions. (2 marks
4. Prove that this arbitrage is riskless. (2 marks)