(Option Strategies/Arbitrage Strategy) Consider the following three European put options with the same underlying non-dividend paying...

 

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(Option Strategies/Arbitrage Strategy) Consider the following three European put options with the same underlying non-dividend paying stock and the same expirations: The first put option has a strike price of $30. Denote the premium of this put option by P30- The second put option has a strike price of $35. Denote the premium of this put option by P35- The third put option has a strike price of $40. Denote the premium of this put option by P40- Assume that P40 + P30 < 2P35- Your colleagues Jeff and Laney claim the following: Jeff: "Because an investor can create a butterfly spread using these European options, there is no arbitrage opportunity." Laney: "I do not agree with Jeff. There is an arbitrage opportunity." Who is correct? If you believe Jeff is correct, explain why Jeff is correct. If you believe Laney is correct, show that if P40 + P30 < 2p35 holds, you can create an arbitrate strategy to exploit an arbitrage opportunity. When you do so, describe your strategy in detail and carefully show that your strategy leads to arbitrage profits. (Option Strategies/Arbitrage Strategy) Consider the following three European put options with the same underlying non-dividend paying stock and the same expirations: The first put option has a strike price of $30. Denote the premium of this put option by P30- The second put option has a strike price of $35. Denote the premium of this put option by P35- The third put option has a strike price of $40. Denote the premium of this put option by P40- Assume that P40 + P30 < 2P35- Your colleagues Jeff and Laney claim the following: Jeff: "Because an investor can create a butterfly spread using these European options, there is no arbitrage opportunity." Laney: "I do not agree with Jeff. There is an arbitrage opportunity." Who is correct? If you believe Jeff is correct, explain why Jeff is correct. If you believe Laney is correct, show that if P40 + P30 < 2p35 holds, you can create an arbitrate strategy to exploit an arbitrage opportunity. When you do so, describe your strategy in detail and carefully show that your strategy leads to arbitrage profits.

Answer rating: 100% (QA)

Laney is correct there is an arbitrage opportunity given the condition P40 P30 2P35 To exploit this arbitrage opportunity we can create a butterfly spread using the three European put options Heres ho... View the full answer