# Question

Consider Commodity Z, which has both exchange-traded futures and option contracts associated with it. As you look in today’s paper, you find the following put and call prices for options that expire exactly six months from now:

a. Assuming that the futures price of a six-month contract on Commodity Z is $48, what must be the price of a put with an exercise price of $50 in order to avoid arbitrage across markets? Similarly, calculate the "no arbitrage" price of a call with an exercise price of $45. In both calculations, assume that the yield curve is flat and the annual risk-free rate is 6 percent.

b. What is the "no arbitrage" price differential that should exist between the put and call options having an exercise price of $40? Is this differential satisfied by current market prices? If not, demonstrate an arbitrage trade to take advantage of themispricing.

a. Assuming that the futures price of a six-month contract on Commodity Z is $48, what must be the price of a put with an exercise price of $50 in order to avoid arbitrage across markets? Similarly, calculate the "no arbitrage" price of a call with an exercise price of $45. In both calculations, assume that the yield curve is flat and the annual risk-free rate is 6 percent.

b. What is the "no arbitrage" price differential that should exist between the put and call options having an exercise price of $40? Is this differential satisfied by current market prices? If not, demonstrate an arbitrage trade to take advantage of themispricing.

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