Box-Spread Question? Q17 Exam 2

[ebb]

A stock is trading USD 100. A box spread with 1 year to expiration and strikes at USD 120 and USD 150 is trading at USD 20. The price of a 1-year European call option with strike USD 120 is USD 5 and the price of a European put option with same strike and expiration is USD 25. What strategy exploits an arbitrage, if any?

a. Short (1) put, short (1) unit of spot, buy one call, and buy six unit box-spread

b. Buy (1) put, short (1) unit of spot, short (1) call, buy (4) units of box-spread

c. Buy (1) put, buy (1) unit of spot, short (1) call, and short (6) units of box-spread

d. There are no arbitrage opportunities

The answer (A) seems to point to the number $30 expected profit at expiration for the box spread.

How was that number arrived? Is it just the difference between $150 and $120? So can I take it that for box spreads, the expected profit is simply the difference in the high and low strike prices? Suggesting a $20 investment can earn a $30 (50% return) expected payoff in this particular question?

Thanks

 

[David Harper CFA FRM]

See Alan's help (from last year) here @
http://forum.bionicturtle.com/threa...-this-awaiting-your-response.4474/#post-11557

 

[Jogarmenina]

Hi David

The above link cannot be opened. Would you mind to post the response again? I have been trying on this question but cannot understand how to get answer A as the correct answer. Thank you.

 

[Almondchoco]

Hi David,

I couldn't open the above link either. It would be much appreciated if you could post the response again. Thank you so much.

 

[Dr. Jayanthi Sankaran]

Hi @Jogarmenina and @Almondchoco - I could easily open the link. Maybe it has something to do with your browser settings.

 

[Nicole Seaman]

@Almondchoco The link that you are referring to is for paid members. The upper portion of the forum is for all members, but the lower portions of the forum are only for paid members. You can view all of our packages HERE. If you purchase a study package, you will gain full access to all areas of the forum.

Thank you,

Nicole

 

[Dr. Jayanthi Sankaran]

Thanks a lot Nicole - I was just explaining Alan's solution to him - did not know that he was an unpaid member.

Jayanthi

 

[Arka Bose]

Yea, the strategies remain the same, but I was doing like this, r=50%.
Now, I try to find the risk free rate from the normal put call parity equation, where r comes at 0.
Thus, bond is overpriced in PCP, so call has to be under priced and put is overpriced (using p=Bond-Spot), also, since the rate as per PCP comes to 0, the rate from box spread is 50%, I will surely buy that box spread.
Thus, I will go long on box and the call and short the put