AppliedMultiple choice
A quote sheet with a hole in it · Part 2 of 3
A market maker quotes European calls on a stock at $100, all with the same expiry: the 90-strike at $14.00, the 100-strike at $8.00 and the 110-strike at $1.50. Interest rates are zero and you can trade at these prices.
Given that the butterfly is quoted at a credit, which trade is an arbitrage and what is its worst outcome at expiry?
- ABuy the butterfly; the worst case keeps the $0.50 credit
- BSell the butterfly; the worst case is a loss of $0.50 if the stock pins at 100
- CBuy the 100-strike call outright, since it must be too cheap relative to its neighbours
- DBuy the butterfly; the worst case is losing the $10 maximum payoff if the stock ends at 100
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