If a call is overvalued, put-call parity suggests
That the investor should
A) sell the call and the stock and buy the put and the bond
B) sell the call and the bond and buy the put and the stock
C) sell the bond and the put and buy the stock and the call
D) sell the stock and the put and buy the call and the bond

Question

Quizplus · Accepted Answer

Put-call parity suggests that a call option is overvalued when its price is greater than the sum of the present value of the exercise price and the price of a put option with the same exercise price and expiration date as the call. In this case, the investor can profit by selling the overpriced call and buying an underpriced put option, while also selling the bond and using the proceeds to buy the underlying stock. By doing so, the investor can lock in a riskless profit equal to the difference between the call price and the put price, which is guaranteed by the arbitrage relationship implied by put-call parity. Therefore, the best choice is to sell the call and the bond and buy the put and the stock (choice letter B).

If a Call Is Overvalued, Put-Call Parity Suggests