The common stock of the Avalon Corporation has been trading in a narrow range around $40 per share for months, and you believe it is going to stay in that range for the next three months. The price of a three-month put option with an exercise price of $40 is $3, and a call with the same expiration date and exercise price sells for $4.
-How can you create a position involving a put,a call,and riskless lending that would have the same payoff structure as the stock at expiration?
A) Buy the call, sell the put; lend the present value of $40
B) Sell the call, buy the put; lend the present value of $40
C) Buy the call, sell the put; borrow the present value of $40
D) Sell the call, buy the put; borrow the present value of $40

Question

Quizplus · Accepted Answer

By buying the call option with an exercise price of $40 and selling the put option with the same exercise price, the investor creates a synthetic long position that will have the same payoff as owning the stock at expiration. To fund the purchase of the call and the short sale of the put, the investor can lend the present value of $40, which is the exercise price. This will allow the investor to earn interest on the lending while maintaining the synthetic long position. Hence, option A is the best choice.

The Common Stock of the Avalon Corporation Has Been Trading