An asset is trading for $45. Three months American 40 calls and puts are selling for $7 and $3, respectively. The risk-free rate is 10% per annum. Specify an arbitrage strategy and the gain you could make. Justify your answer.
Added by Pedro H.
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Step 1
To set up the arbitrage strategy, we need to buy the cheaper option (put) and sell the more expensive option (call). The cost of buying the put option is $3, and the revenue from selling the call option is $7. Therefore, the net cost of setting up the strategy is Show more…
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