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Answer to Question #59649 in Finance for Lucille Sikosana

Question #59649
Option prices exist on a particular day for ABC shares. They all have same expiration date. Strike Price = $40. $50, $55 Call Price = $11, $6. $3 Put Price = $3, $8, $11. A market analyst believes there is an arbitrage opportunity available using the above market prices. She believes that that the following portfolio produces a risk free profit:Long 2 calls and short 2 puts with strike price 55; long 1 call and short 1 put with strike price 40; lend $2; and short 3 calls and long the same number of puts with strike price 50. You may assume a one period time horizon between T0 (current cash flow) and T1 (cash flow on exercise of the options). Remember to record the result of the analysis by indicating whether an opportunity indeed exists. Buy 2 calls and sell 2 puts (strike price = $55) Buy one call and sell one put (strike price =$40) Lend %2 at the market rate of 5% Sell 3 calls and buy 3 puts (strike price = $50) What is the Total? Arbitrage opportunity?
Expert's answer
Strike Price = $40, $50, $55,
Call Price = $11, $6, $3,
Put Price = $3, $8, $11.
The total is: -2*$3 + 2*$11 - $11 + $3 ­ $2 - 3*$6 + 3*$8 - 2*$3 + 2*$11 - 11 + 3 - 2 + 3*$6 - 3*$8 = $12.
So, the arbitrage opportunity is $12.

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