Tempting Twitter Trade
TWTR stock is trading at $36.70. It offers no dividends. The European call on the $35 strike with 10 days to expiry is valued at $4.70. A broker calls up with a market on the European put on the $31 strike with 10 days to expiry and has a market of $3.00 bid at $3.10. What trade do you want to make?
Assume that interest rate is 0%.
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1 solution
The $35 call is $1.70 in the money, hence it has an extrinsic value of $4.70 - $1.70 = $3.00.
By Put Call Parity, the value of the put on the $35 strike is $3.00. Since the value of the put on the lower strike $31 should be much lower than the value of the put on the higher strike $35, this tells us that we should be wanting to sell the $31 put for $3.00
If the $35 put is available to be bought for $3.00, then we can trade the 35-31 put spread for no cost (ignoring transaction fees), and we are guaranteed non-negative returns on this position (assuming that we simply let the position expire without performing trades against it).
If the $35 put is not available, we can trade it synthetically by buying the $35 call, and selling the TWTR stock against it.