Question

7. Given the following market prices determine what arbitrage trading situation exists and what the expected profit would be for this trade –

XYZ 60 Call @ 6.00

XYZ 65 Call @ 3.75

XYZ 60 Put @ 2.00

XYZ 65 Put @ 4.50

Answer 1

A box spread arbitrage exists.

A box spread is created by :

• Buying (long position) in 60 call
• Selling (short position) in 65 call
• Buying (long position) in 65 put
• Selling (short position) in 60 put

Payoff of a long call option = Max[S-X, 0] - P

Payoff of a short call option = P - Max[0, S-X]

Payoff of a long put option = Max[X-S, 0] - P

Payoff of a short put option = P - Max[0, X-S]

S = underlying price at expiry,

X = strike price

P = premium paid or received (long options involve paying premium, and short options receive premium)

Arbitrage profit = $0.25

Expected arbitrage profit = $0.25