Thomas Duckworth owns and operates Stones Asset Management.The firm manages $10 billion in assets and focuses on exploiting arbitrage opportunities.Duckworth uses put - call parity to price put and call options.According to his put - call parity analysis Duckworth realizes that puts with a strike price of $30 and 1 month remaining until expiration on Medusa's Inc.should be priced at $2.30.However he realizes that the $30 puts are trading for $2.75 in the open market.How should Duckworth exploit this arbitrage opportunity?

Question

Quizplus · Accepted Answer

If Duckworth executes the strategy correctly he should be able to earn a risk - free profit of $.45.Based on his analysis the puts are overpriced in the market.Therefore he should sell the puts in the open market and synthetically create a long position in the puts.He can accomplish this by lending $30 at the risk free rate(B),buying a $30 1 month call(C)on the stock,and shorting Medusa's stock(-S).Using the equation S+P=B+C,Duckworth is solving for P.Therefore P=B+C-S

Thomas Duckworth Owns and Operates Stones Asset Management