Question

If the option price is out of its boundary, what is the arbitrage strategy you would use?

Answer #1

The most basic strategy I would use and have used would be buying both call and put option at a cheap price which means that the strike price are going to be wide. Why cheap price? Because it is easier for a lower value to touch 0 and maximise your loss from then on. All you would need is good volatility so let's say you buy these two options at $5 each, and good volatility favouring call (it can be put) would reduce the value of the put option to max 0 but increasing the price of call above 10 (break even) and further to unlimited.

- Low option price
- High volatility
**High maturity**

Time these 3 right and you've yourself a great strategy.

You want to use an investment strategy by selling a call option
and a put option. Answer the next three questions using the
following information. Sell a call option with an exercise price of
$1.54 for a premium of $0.03. Sell a put option with an exercise
price of $1.54 for a premium of $0.03.
A. this type of strategy is called a:
a. long butterfly b. short butterfly c. long straddle d. short
straddle
B.this strategy would be profitable...

1. A European call option and put option on a stock both have a
strike price of $20 and an expiration date in three months. Both
sell for $3. The risk-free interest rate is 10% per annum, the
current stock price is $19, and a $1 dividend is expected in one
month. Is there an arbitrage opportunity? If there is an arbitrage
opportunity, clearly state what condition must be satisfied to
eliminate the arbitrage opportunity. What is the strategy
followed...

What is the arbitrage opportunity when 6-month forward price is
out of line with spot price for asset providing no income (asset
price =$50; forward price=$55; interest rate=6%; maturity of
forward contract =6 months)?

Which of the following would be an advantage of a short straddle
option strategy?
a. A precipitous drop in price
b. A precipitous rise in price
c. The price of the underlying asset remains near the strike
price
d. None of the would be a disadvantage of a straddle

Show the profile of the butterfly option strategy for the stock
price range $65 - $95 (5):
Buy 100 $72 call @ $6.10
Sell 200 $75 calls @ $4.10
Buy 100 $78 call @ $2.60
Current price is $75.28. On which
stock price interval is this strategy profitable?
(2)What is the maximum profit/loss of this
strategy? (2)When will you engage in this
strategy? (1)

A trader conducts a trading strategy by selling a call option
with a strike price of $50 for $3 and selling a put option with a
strike price of $40 for $4. Please draw a profit diagram of this
strategy and identify the maximum gain, maximum
loss, and break-even point. Hint: Write down a profit
analysis matrix to help you draw the payoff lines.

The strike price for a European call and put option is $56 and
the expiration date for the call and the put is in 9 months. Assume
the call sells for $6, while the put sells for $7. The price of the
stock underlying the call and the put is $55 and the risk free rate
is 3% per annum based on continuous compounding. Identify any
arbitrage opportunity and explain what the trader should do to
capitalize on that opportunity....

suppose that P is the price of a European put option to see a
security whose present price is S. Let K be the strike price of the
option. Show that if P>K then there is a buying and/or selling
strategy that yields risk-less profit at expiration (ie arbitrage
is present)

Explain how each trader would set up a strategy to carry out
their intended purpose. Be as specific as possible in each case, by
providing details about the strategy: the position (whether long or
short), the size of the exposure (notional amount), the number of
contracts involved (if more than one), the expiration date of the
contracts, etc. In each case, explain whether the trader will
realize a profit or a loss if the underlying asset/variable
increases by 10%. An...

A strap option strategy is created by purchasing two call
options and one put option of the same underlying stock. The
options have the same exercise price (E=50) and same expiration
date.
a) What is the payoff of the strategy is the stock price is
$0?
c) What is the payoff of the strategy is the stock price is
$100?

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