Rankin Corp.common stock is priced at $74.20 per share.The company just paid its $1.10 quarterly dividend.Interest rates are 6.0%.A $70.00 strike European call,maturing in 6 months,sells for $6.50.How much arbitrage profit/loss is made by shorting the European call,which is priced at $2.50?
A) $0.12 loss
B) $0.12 gain
C) $0.36 loss
D) $0.36 gain

Question

Quizplus · Accepted Answer

To calculate the arbitrage profit or loss, we first need to determine the fair value of the European call option using the Black-Scholes model or a similar valuation method. However, without doing complex calculations, we can understand the scenario qualitatively. The question mentions that the European call is priced at $2.50, which seems to be a mistake because it's stated that the call sells for $6.50. Assuming the intention is to compare the actual trading price ($6.50) with a theoretical or implied price ($2.50), the arbitrage opportunity arises from the difference in these prices. If you can short sell the call at its market price ($6.50) and the theoretical cost to cover this position later (or the fair value) is indeed $2.50, then the profit per share before costs would be $6.50 - $2.50 = $4.00. However, since none of the provided choices match this calculation, and given the information provided, it's not possible to accurately calculate the arbitrage profit or loss based on standard financial formulas without additional information or clarification on the discrepancy in the call pricing. Therefore, the correct answer based on the choices given and assuming a misinterpretation in the question setup would be to identify a gain, but the exact calculation provided in the choices does not align with the typical method for calculating arbitrage in options trading.