Derivatives**Option Binomial MOdel*******

[nitish3861]

Hello,
When the Put Option is Overpriced ,to take advantage of the arbitrage ,we are are selling the put Option & at the same time Shorting the Undelying Stock,whereas in the case of Call Option(Overpriced) we are Selling the Call Option & going Long on the Stock ?
Can anyone Explain why we are shorting the Stock in the case of Put Option.

 

[S2000magician]

Take a look at put-call parity:
p + S = c + PV(X)
If you solve for the put price, you get,
p = c + PV(X) – S
If the put is overpriced, then you buy the right side (buy a call, buy a bond, sell the stock) and sell the put. If the put is underpriced, then you buy the put, sell a call, sell a bond, and buy the stock.

 

[nitish3861]

Thank you Magician Sir……….Got the Concept

 

[S2000magician]

Good to hear.
You’re quite welcome.