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+Chapter 27: Arbitrage 439 
+Example 1: XYZ is sold short at 60, and a January 50 call is bought for 10¼ points. 
+Assume that the prevailing interest rate is 1 % per month and that the position is 
+established one month prior to expiration. XYZ pays no dividend. The total credit 
+brought in from the trades is $4,975, so the arbitrageur will earn $49.75 in interest 
+over the course of 1 month. If the stock is above 50 at expiration, he will exercise his 
+call to buy stock at 50 and close the position. His loss on the security trades will be 
+$25 the amount of time value premium paid for the call option. (He makes 10 
+points by selling stock at 60 and buying at 50, but loses 10¼ points on the exercised 
+call.) His overall profit is thus $24.75. 
+Example 2: A real-life example may point out the effect of interest rates even more 
+dramatically. In early 1979, IBM April 240 calls with about six weeks of life remain­
+ing were over 60 points in-the-money. IBM was not going to be ex-dividend in that 
+time. Normally, such a deeply in-the-money option would be trading at parity or even 
+a discount when the time remaining to expiration is so short. However, these calls 
+were trading 3½ points over parity because of the prevailing high interest rates at the 
+time. IBM was at 300, the April 240 calls were trading at 63½, and the prevailing 
+interest rate was approximately 1 % per month. The credit from selling the stock and 
+buying the call was $23,700, so the arbitrageur earned $365.50 in interest for 1 ½ 
+months, and lost $350 - the 3½ points of time value premium that he paid for the 
+call. This still left enough room for a profit. 
+In Chapter 1, it was stated that interest rates affect option prices. The above 
+examples of the "interest play" strategy quite clearly show why. As interest rates rise, 
+the arbitrageur can afford to pay more for the long call in this strategy, thus causing 
+the call price to increase in times of high interest rates. If call prices are higher, so 
+will put prices be, as the relationships necessary for conversion and reversal arbitrage 
+are preserved. Similarly, if interest rates decline, the arbitrageur will make lower 
+bids, and call and put prices will be lower. They are active enough to give truth to the 
+theory that option prices are directly related to interest rates. 
+THE BOX SPREAD 
+An arbitrage consists of simultaneously buying and selling the same security or equiv­
+alent securities at different prices. For example, the reversal consists of selling a put 
+and simultaneously shorting stock and buying a call. The reader will recall that the 
+short stock/long call position was called a synthetic put. That is, shorting the stock 
+and buying a call is equivalent to buying a put. The reversal arbitrage therefore con­
+sists of selling a (listed) put and simultaneously buying a (synthetic) put. In a similar