Suppose options trade at two strikes K 1 K 2 You notice that whereas C(K 2 ) P(K 2 ) S PV(K 2 ) (put call parity) holds for the K 2 strike option, it does not hold for the K 1 strike option, specifically C(K 1 ) P(K 1 ) S PV(K 1 ) , where 0 Show how you would use a box spread to take advantage of t...

A box spread is the difference of two collars We will buy the K collar and sell the K2 co ...

Suppose options trade at two strikes: K 1 < K 2 . You notice that whereas C(K

Question:

Suppose options trade at two strikes: K₁ < K₂. You notice that whereas C(K₂) − P(K₂) = S − PV(K₂) (put-call parity) holds for the K₂ strike option, it does not hold for the K₁ strike option, specifically C(K₁) − P(K₁) = S − PV(K₁) + δ, where δ > 0. Show how you would use a box spread to take advantage of this situation by constructing a riskless arbitrage strategy. Assume there are no dividends.