If the observed put option premium is less than what is suggested by the put-call parity equation, astute arbitrageurs could make a profit by ____ the put option, ____ the call option, and ____ the underlying currency.
A) selling; buying; buying
B) buying; selling; buying
C) selling; buying; selling
D) buying; buying; buying

Question

Quizplus · Accepted Answer

According to put-call parity, the premium of a put option should be equal to the premium of a call option minus the present value of the strike price discounted to the expiration date. If the observed premium of the put option is less than what is suggested by put-call parity, there is an arbitrage opportunity. To take advantage of this, one should buy the put option, sell the call option and buy the underlying currency. This will result in a riskless profit equal to the difference between the observed put option premium and the premium suggested by put-call parity. Choice B matches these actions.

If the Observed Put Option Premium Is Less Than What