Question: (Taken from tutorial 4, question 4)
You can assume that a non-dividend paying share that has a current price of R125 will have a price of either R110 or R140 6 months from now, depending on the state of the economy. The continuously compounded risk free rate of interest is 10% per annum.
If a call on this share with 6 months to maturity and a strike price of R130 was currently trading at R7,50 in the market, show that an arbitrage opportunity would exist by describing a trading strategy that has zero cost at time 0 and a positive value at maturity (i.e. in 6 months from now). Calculate the value at maturity.
I am not sure how calculating the theoretical call price indicates the exact strategy that is needed to create an arbitrage (especially the part about selling 3 calls).
Also are there many possible trading strategies that can be chosen, if so how do you go about finding them.