Question 2.2

Briefly discuss a situation where it may be advisable to combine the two positions

illustrated on the previous page and describe what the combined payoff would

resemble.

(4)

Question 2.3

The following option prices exist on a particular day for ABC shares. They all have the

same expiration date. 

A market analyst believes there is an arbitrage opportunity available using the above

market prices. She believes that that the following portfolio produces a risk free profit:

Long 2 calls and short 2 puts with strike price 55; long 1 call and short 1 put with strike

price 40; lend R2; and short 3 calls and long the same number of puts with strike price

50. 

5

Complete the table on the following page to check if there is indeed an arbitrage profit

opportunity. You may assume a one period time horizon between T0 (current cash flow)

and T1 (cash flow on exercise of the options). Remember to record the result of the

analysis by indicating whether an opportunity indeed exists.

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