1) Upper Bound: European Put Arbitrage
Suppose that:
Show that there is an arbitrage opportunity.
Show how you would exploit the arbitrage opportunity.
What is your minimum gain?
Hint: Sell the put (it’s worth too much) and invest proceeds. Then find the maximum possible cash outflow due to the short put position at maturity.
2) Lower Bound: European Put Arbitrage
Suppose that:
p $1 S0 $37
T 0.5 r 5%
K $40
Show that there is an arbitrage opportunity.
Show how you would exploit the arbitrage opportunity.
What is your minimum gain?
3) Put Call Parity (European)
Suppose that:
c $3 S0 $31
T 0.25 r 10%
K $30 p $2.25
Show that there is an arbitrage opportunity.
Show how you would exploit the arbitrage opportunity.
What is your minimum gain?
Sample Solution