1. Explain why a European call on a stock that pays no dividends is never exercised early. What would you do instead to eliminate the call option position?
2. A stock is trading at S = $60. There are one-month American calls and puts on the stock with a strike of $60. The call costs $2.50 while the put costs $1.90. No dividends are expected on the stock during the options’ lives. If the one-month rate of interest (annualized) is 3%, show that there is an arbitrage opportunity available and explain how to take advantage of it.
Is there a manner to set-up a model to assess and identify arbitrage opportunities such as this one?