A non-dividend paying stock is selling for $3.95 and the risk-free interest rate is 1%. A three-month European call option with a strike price of $4.00 is selling for $0.35. A three-month European put option with a strike of $4.00 is trading at $0.50. What would an arbitrageur do?
I Guess you can use S= C-P + X/(1+RFR)^T
I Guess you can use S= C-P + X/(1+RFR)^T C-P+x/(1+RFR)^T = 0.35 - .5 + 4/(1+1.01)^90/360 = 0.35 -0.5 + 4 = 3.85 Stock is trading at 3.95 So he should short the stock and go long with this combination. I am not sure but i think this should be it. Let me know if I am correct or not
the idea is right: create synthetic instrument -> buy “underpriced”, sell “overpriced”