Explanation:
To sell a box spread, an investor must sell a European call option and buy a European put option with a specific strike price (X1), and simultaneously buy a European call option and sell a European put option with a higher strike price (X2). This strategy is known as a box spread strategy. A box spread is a complex strategy that involves four options with the same expiration date but different strike prices. The goal of this strategy is to create a risk-free position that can potentially generate arbitrage profits. The box spread strategy is often used by sophisticated investors like Phillip Harris who have a deep understanding of options pricing and can identify mispriced options in the market. When the market value of a box spread is higher than the present value of its payoff, it indicates that the options are overpriced. By selling the box spread, the investor can lock in a guaranteed profit regardless of the future price movements of the underlying asset. This is because the payoff from the box spread at expiration will always be equal to the difference between the two strike prices, regardless of the price of the underlying asset. Therefore, if the investor can sell the box spread for more than this amount, they can earn an arbitrage profit.
Choice A is incorrect. This choice suggests buying both a call and a put option at strike price X1, and selling both a call and a put option at strike price X2. This strategy would actually create a long box spread position, not the short box spread position that Harris needs to profit from an inflated box spread.
Choice B is incorrect. This choice suggests selling both a call and a put option at strike price X1, and buying both a call and a put option at strike price X2. This is the opposite of what is required and would also create a long box spread position.
Choice C is incorrect. This choice suggests buying a call and selling a put at strike price X1, and selling a call and buying a put at strike price X2. This is not the correct configuration for selling a box spread.
No comments yet.
Q.773 Phillip Harris is a senior arbitrageur investor at Dynamic Arbitrage Investment Co. He recently found out that if the value of a box spread is not equal to the present value of the payoff of the box spread, an investor could earn an arbitrage profit. He also found out that if the market value of a box spread is too high, it is profitable to sell the box spread. What positions should Harris take in call and put options to sell a box spread?
A
Harris must buy a European call option and buy a European put option with a specific strike price (X1), and simultaneously sell a European call option and sell a European put option with a higher strike price (X2).
B
Harris must sell a European call option and sell a European put option with a specific strike price (X1), and simultaneously buy a European call option and buy a European put option with a higher strike price (X2).
C
Harris must buy a European call option and sell a European put option with a specific strike price (X1), and simultaneously sell a European call option and buy a European put option with a higher strike price (X2).
D
Harris must sell a European call option and buy a European put option with a specific strike price (X1), and simultaneously buy a European call option and sell a European put option with a higher strike price (X2).