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Put options with strikes of 70, 75, and 80 have option premiums of 4.00, 8.00, and...

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Finance

Put options with strikes of 70, 75, and 80 have option premiumsof 4.00, 8.00, and 11.00, respectively. Given this information, inwhich way can you undertake an arbitrage?

Answer & Explanation Solved by verified expert
4.4 Ratings (869 Votes)

Here price gap between exercise price is 5$ , however there is difference in price gap of premiums
For 70 PE it is 4$ for 75 PE it is 8$ and for 80PE is 11$ which should had been 12$
Thus there is arbitrage opportunity

Buy a P(70) and a P(80), Short two P(75)

Table showing pay off

Price at expiry Bought PE @70 2 short PE @75 Bought PE @80 Premium
([2*8] - (4+11))		 Net profit and loss
60 10 -30 20 1 1
61 9 -28 19 1 1
62 8 -26 18 1 1
63 7 -24 17 1 1
64 6 -22 16 1 1
65 5 -20 15 1 1
66 4 -18 14 1 1
67 3 -16 13 1 1
68 2 -14 12 1 1
69 1 -12 11 1 1
70 0 -10 10 1 1
71 -8 9 1 2
72 -6 8 1 3
73 -4 7 1 4
74 -2 6 1 5
75 0 5 1 6
76 4 1 5
77 3 1 4
78 2 1 3
79 1 1 2
80 0 1 1
81 1 1
82 1 1
83 1 1
84 1 1
85 1 1
86 1 1
87 1 1
88 1 1
89 1 1
90 1 1

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Transcribed Image Text

Put options with strikes of 70, 75, and 80 have option premiumsof 4.00, 8.00, and 11.00, respectively. Given this information, inwhich way can you undertake an arbitrage?

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