Question

1. Mazzi Corp. shares are currently trading at RM14.00 each. A three-month put option on this share is priced RM0.50 at a strike price of RM15.00. The risk free interest is 10% per annum for all maturities. Observing this data, identify and calculate what are the arbitrage opportunities available.

Answer 1

The arbitrage options available are

1) Buying a put option by paying RM 0.50 and a share at its current price RM 14.

            Total Initial Amount required = RM 0.50+RM 14 = RM 14.50.

2) Amount to be paid for borrowing of RM 14.50 after 3 months, along with interest = RM 14.50+ [RM 14.50*10%*3/12] = RM 14.8625.

3) In case the per share market price after 3 months is greater than RM 15, then arbitrageur will exercise the option to sell and in case it is below RM 15 then put option will be exercised by arbitrageur and will share sell at RM15 ( at which the put option was actually bought). So the minimum price that can be received is RM 15 by using put option.

4) After 3 months minimum arbitrage gain = Strike price (RM 15) - Paid (RM 14.8625)

                                                                 = RM 0.1375