10.11. A four-month European call option on a dividend-paying stock is currently selling for $5.
The stock price is $64, the strike price
is $60, and a dividend of $0.80 is expected in one month. The risk-free interest rate is 12% per annum for all maturities. What opportunities are there for an arbitrageur?
t=4 , s 0=64 , k=60 , r=0.12, D=0.8 , c=5
present value for strike price k e−rt =60 e−0.12 ×4 /12=57.65 present value for dividend D e−rt =0.8 e−0.12× 1/ 12=0.79 Because s0 −D−k e−rt =64−0.79−57.65=5.56> c=5 so the arbitrageur should buy the option and short the stock. 1. If the stock price declines below $60 in four months , the present value of arbitrageur’s gain is 64−0.79−57.65=5.56 5.56−5=0.56 2. If the stock price is above $60 in four months , the present value of arbitrageur’s gain is 64−0.79−57.65=5.56 5.56−5=0.56