Researchers use the option-implied stock price derived from put-call parity to analyse stock return predictability identified by option prices. They argue that when transaction costs are considered, put-call parity for European options becomes a set of inequalities (as depicted in the attached picture):

(a) Suppose that (1) is not satisfied. How would you arbitrage this? Include a cash flow table in your answer. (b) Suppose that the option-implied value is above the price at which the stock is currently trading. On average, this stock will earn a positive return in the near future. What are the two potential explanations that the literature has put forward for this phenomenon?

SASK ZC -Cask Ke"I + P Bid CBid + Ke-T + Ke T PASK ZS BID SASK ZC -Cask Ke"I + P Bid CBid + Ke-T + Ke T PASK ZS BID