Hi, just a small question from the master of finance course. The question asks to say and explain whether there is an arbitrage opportunity if the bid price of a deep in-the-money option is substantially less than the ask price. Here is the original answer given by a PhD student: there could be an arbitrage opportunity if one purchases the option at the bid price and long index, but one can only purchase at the ask-price.
I think this question is pretty intuitive, but this explanation is not even practical and not answer the question at all. Nobody can buy the option at the bid-price except the dealer, and this kind of option is even not liquid. There should be no implication of an arbitrage opportunity here, and the only thing about the low bid-price is that the dealer finds it difficult to sell the contract to a buyer, and that's why the dealer offers a pretty low price for compensating potential liquidity risk.
Any better idea than the original answer?
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Hi, just a small question from the master of finance course. The question asks to say and explain whether there is an arbitrage opportunity if the bid price of a deep in-the-money option is substantially less than the ask price. Here is the original answer given by a PhD student: there could be an arbitrage opportunity if one purchases the option at the bid price and long index, but one can only purchase at the ask-price. I think this question is pretty intuitive, but this explanation is not even practical and not answer the question at all. Nobody can buy the option at the bid-price except the dealer, and this kind of option is even not liquid. There should be no implication of an arbitrage opportunity here, and the only thing about the low bid-price is that the dealer finds it difficult to sell the contract to a buyer, and that's why the dealer offers a pretty low price for compensating potential liquidity risk. Any better idea than the original answer?