An American call option, with an exercise price of $5, sells for $2; the stock price is $8 presents an arbitrage opportunity. (Assume no transaction costs and any option can be exercised immediately).

Question

Quizplus · Accepted Answer

Since the stock price ($8) is higher than the exercise price ($5) by $3, buying the call option for $2 and immediately exercising it to buy the stock results in an instant profit of $1 ($3 - $2), indicating an arbitrage opportunity.

An American Call Option, with an Exercise Price of $5