Illustrates an example of Arbitrage

Question

Illustrates an example of Arbitrage?

Answer 1

An at-the-money European call option along with a strike of $100 and an expiration of six months is worth $8. A European put with identical strike and expiration is worth $6. There are no dividends upon the stock and a six-month zero-coupon bond along with a principal of $100 is worth $97.

Buy the call and a bond and also sell the put and the stock, that will bring in $ − 8 − 97 + 6 + 100 = $1. At expiration that portfolio will be worthless in spite of the final price of the stock. You will make a profit of $1 with no risk. It is arbitrage. It is an illustration of the violation of put–call parity.