CFA Practice Question

CFA Practice Question

On the Pacific Exchange, the market for the April 85 put contract on Meritum Semiconductor is $4.35 bid -4.85 ask, and the price of Meritum common stock is $88.32. On the Chicago Board Options Exchange, the market for the same April 85 put contract is $4.25 bid -4.30 ask. Assuming no transaction costs, and an unlimited depth on both exchanges at the specified prices, what is the amount of this arbitrage opportunity?
A. Unlimited
B. $50
C. There is no arbitrage opportunity
Explanation: An arbitrage opportunity is defined as a discrepancy in the pricing of a security which allows for the realization of riskless profits. "Depth" refers to the amount of a security which can be purchased or sold at the posted price. In this example, the option contract is offered $.05 lower on the Chicago Board Options Exchange than it is bid on the Pacific Exchange, and because the question specified that the depth was unlimited on both exchanges at the prices posted, the realization of unlimited profits is theoretically possible.

User Contributed Comments 2

User Comment
FozzeyBear This isn't true, because the bid and ask are for only a certain amount of contracts. With each contract bought/sold the bid ask would converge until no arbitrage opportunity is left.
merc5559 DEPTH FOZZEY DEPTH
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