Calculate the payoff from a box spread at expiration

Reference no: EM131953302

Question: The so-called "box spread" consists of four options: long E1 call, short E1 put, short E2 call and a long E2 put.

1. Calculate the payoff from a box spread at expiration, in terms of E1 and E2.

2. Use put-call parity to calculate the price of the box spread at time t = T - t before expiration, if the risk-free rate is r > 0. You do not need to know the prices of the individual options to price the box spread!

3. Give an explanation for your answer from the "no-arbitrage" point of view.

4. Profits from option trading are often taxed at a reduced rate (because the investor undertakes risk), when compared to tax rate on wage or (risk-free) interest earnings. Why do you think the IRS takes a dim view of using box spreads?

Reference no: EM131953302

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