Question

A put option with strike price \(60 trading on the Acme options exchange sells for \)2. To your amazement, a put on the firm with the same expiration selling on the Apex options exchange but with strike price \(62 also sells for \)2. If you plan to hold the options position until expiration, devise a zero-net-investment arbitrage strategy to exploit the pricing anomaly. Draw the profit diagram at expiration for your position.

Short answer

a. As below

Step-by-step solution

Calculation of zero-net-investment arbitrage strategy

Position	ST < 60	60 < ST < 62	ST > 62
Long Put (X=62)	62 -ST	62 -ST	0
Short put (X =60)	-(60-ST )	0	0
Total	2	62 -ST	0

Since the net outlay is zero and options have the same price, the proceeds will never be negative and lie between 0 and 2

Graphical representation of profit diagram at expiration’