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Showing results for tags 'arbitrage option strategy'.
Found 7 results
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Lock-up options are usually priced in such a way as to deter unwanted buyers and attract only the buyers that the option owners want to sell to.
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This is a low-risk strategy which aims for getting small returns on the trade on expiry. It is a complicated strategy that is best suited for advanced traders.
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This is a trade strategy in which the trader holds a position in an option and a contrary directional position in the asset itself. It is a delta-neutral strategy which can be used to balance out response of the asset to market movements when implied volatility declines.
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Traders who implement a conversion strategy are taking advantage of overpriced assets by instantly liquidating (arbitraging) them to fair market value. The technique involves selling and purchasing a put and a call option, at-the-money, while going long on the underlying asset. Traders can earn a small, risk-free profit when converting options, as long as the option's strike prices exceed the prices of the associated underlying asset. Moneyness Review for Puts and Calls Call Options: In-The-Money (ITM) = Strike price (less than) Market Price Out-of-The Money (OTM) = Strike price (more than) Market Price Put Options: In-The-Money (ITM) = Strike Price (more than) Market Price Out-of-The Money (OTM) = Strike Price (less than) Market Price Both Put and Call Options At-The-Money (ATM) Strike Price (equals) Market Price How to Carry Out A Conversion Strategy Disney stock is worth $100 (market price) in June. 1) Trader buys 100 shares of Disney stock. 2) Trader buys the put option: DISJul100($3) - 100 shares of Disney stock - Strike Price $100, at-the-money (ATM), expiring in 30 days - Premium Cost of $3 3) Trader sell the call option: DISJul100($4) - 100 shares of Disney stock - Strike Price $100, at-the-money (ATM), expiring in 30 days - Premium Cost of $4 4) Trader pays $9900 to enter the conversion. [$9900 (paid for shares) + $400 (received from call) - $300 (paid for put)] Total cost to enter the market: $9900 Result one: Disney stock rises (rallies) to $110 in July. a) The put option purchased expires worthless. (OTM) b) The call option sold expires ITM. c) The investor who bought the trader's call option exercises his or her right to buy 100 shares at $100. d) The trader uses the 100 shares to cover the assignment and receives $10000 from the buyer. e) Trader gains a total of $100 after the subtracting the cost to enter the market from the funds collected from the call option. [$10000 (received from call buyer) - $9900 (cost to enter market)] Result two: Disney stock falls to $90 in July. a) The call option sold expires worthless. (OTM) b) The put option purchased expires ITM. c) The trader exercises his or her right to sell 100 shares at $100, receiving $10000 from the buyer for the long shares purchased when entering the trade. d) The trader's profit totals $100 after the subtracting the cost to enter the market from the funds collected from the put option. [$10000 (received from put seller) - $9900 (cost to enter market)] Calculating The Risk-Free Profit In A Conversion Investors earn instant profits when correctly entering a conversion trade. Market conditions will not matter at the time of expiration, as the synthetic long position covers losses and cancels gains on the long trade. In order to achieve instant profits, the options' strike prices must exceed the difference in the price of the underlying asset less the cost to enter the market. [$100 = $100 (options' strike prices) - $100 (cost to enter market) + $100 (asset price)] Advantages and Disadvantages of Implementing a Conversion : Pluses: The upside to this type of strategy is that the investor will always make a small profit in any market situation, risk-free. The trader is just converting the overpriced options to fair market value. Minuses: There is no downside in carrying out a reversal strategy, since it risk-free. However, traders must be able to recognize overpriced options of which values are higher than their associated underlying asset.
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Traders who implement a box spread or long box strategy are taking advantage of overpriced assets by instantly liquidating (arbitraging) them to fair market value. The technique involves simultaneously entering a bull call and a bear put spread, using options with parallel strike prices. Traders can earn risk-free profit, as long as the expiration value of the box exceeds the cost to enter the spread.Moneyness Review for Puts and Calls Call Options: In-The-Money (ITM) = Strike price (less than) Market Price Out-of-The Money (OTM) = Strike price (more than) Market Price Put Options: In-The-Money (ITM) = Strike Price (more than) Market Price Out-of-The Money (OTM) = Strike Price (less than) Market Price Both Put and Call Options: At-The-Money (ATM) Strike Price (equals) Market Price How To Set Up A Box Spread Strategy Disney stock is worth $45 (market price) in June. Entering the Bull Call Spread 1) The trader writes (sells) a call option: DISJan50($1) - 100 shares of Disney stock - Strike Price $50 (OTM), expiring in 30 days - Premium Cost of $1 2) The trader buys a call option: DISJan40($6) - 100 shares of Disney stock - Strike Price $40 (ITM), expiring in 30 days - Premium Cost of $6 3) The trader pays a total of $500 to enter the bull call spread [$600 (paid for call purchase) - $100 (received from call sale)] Entering the Bear Put Spread 1) Trader writes (sells) a put option: DISJan40($1.50) - 100 shares of Disney stock - Strike Price $40 (OTM), expiring in 30 days - Premium Cost of $1.50 2) Trader buys a put option: DISJan50($6) - 100 shares of Disney stock - Strike Price $50 (ITM), expiring in 30 days - Premium Cost of $6 3) The trader pays a total of $450 to enter the bull call spread [$600 (paid for call purchase) - $150 (received from call sale)] Total cost to enter the market (Box Spread Strategy): $950 [$500 (cost of bull spread) + $150 (cost of bear spread)] Computing Expiration Value To earn risk-free profit, the expiration value of the box must exceed the cost to enter the box spread. The expiration value is simply the difference between the higher and lower strike prices, multiplied by 100. This example's box spread expiration value is $1000 [$1000= $50 (high) -$40 (low) X 100], which is higher than the $950 cost to enter the market. Result one: Disney stays at $45 (ATM) in July. a) Both the put and call options sold expire worthless (OTM). b) The call option purchased is ITM. The trader exercises his or her right to buy 100 shares at $40, pays $4000 to the seller. c) The put option purchased is ITM. The trader exercises his or her right to sell the 100 shares at $50, receives $5000 from the seller. d) The trader's profit is $50 after subtracting the cost to enter the market from the gain. [$50 = $5000 (received from put sale) - $4000 (paid to call seller) - $950 (cost to enter market)] Result two: Disney rallies to $50 in July. a) Both the put and call options sold expire worthless (OTM). b) The call option purchased is ITM. The trader exercises his or her right to buy 100 shares at $40, pays $4000 to the seller. c) The put option purchased is ITM. The trader exercises his or her right to sell the 100 shares at $50, receives $5000 from the seller d) The trader's profit is $50 after subtracting the cost to enter the market from the gain. [$50 = $5000 (received from put sale) - $4000 (paid to call seller) - $950 (cost to enter market)] e) The trader's profit is $50 after subtracting the cost to enter the market from the gain. [$50 = $5000 (received from put sale) - $4000 (paid to call seller) - $950 (cost to enter market)] Result three: Disney falls (crashes) to $40 in July. a) The put and call options sold expire worthless (OTM), as well as the call option purchased. b) The put option purchased is ITM. c) The trader buys 100 Disney shares in the open market, paying $4000 d) The trader sells the 100 shares to the writer at $50, receiving $5000 from the seller. e) The trader's profit is $50 after subtracting the cost to enter the market from the gain. [$50 = $5000 (received from writer) - $4000 (paid for shares) - $950 (cost to enter market)] Advantages and Disadvantages of Implementing a Box Spread Strategy: Pluses: The upside to this type of strategy is that the investor will always make a small profit in any market situation, risk-free. The trader is just settling the overpriced options to fair market value. Minuses: There is no downside in carrying out a box spread strategy, since it risk-free. However, traders must be able to quickly recognize options with expiration values that exceed the investment's costs.
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Traders who implement a reversal strategy are taking advantage of under priced assets by instantly liquidating (arbitraging) them to fair market value. The technique involves selling and purchasing a put and a call option, at-the-money, while short selling the underlying asset. Traders can earn a small, risk-free profit when using a reversal strategy, as long as the two under priced option's values are lower than their associated underlying asset. Moneyness Review for Puts and Calls Call Options: In-The-Money (ITM) = Strike price (less than) Market Price Out-of-The Money (OTM) = Strike price (more than) Market Price Put Options: In-The-Money (ITM) = Strike Price (more than) Market Price Out-of-The Money (OTM) = Strike Price (less than) Market Price Both Put and Call Options At-The-Money (ATM) Strike Price (equals) Market Price How to Carry Out A Reversal Strategy Disney stock is worth $100 (market price) in June. 1) Trader short sells 100 shares of Disney stock. 2) Trader sells the put option: DISJul100($4) - 100 shares of Disney stock - Strike Price $100, at-the-money (ATM), expiring in 30 days - Premium Cost of $4 3) Trader buys the call option: DISJul100($3) - 100 shares of Disney stock - Strike Price $100, at-the-money (ATM), expiring in 30 days - Premium Cost of $3 4) Trader receives a $10100 credit when entering the market. [$10000 (received from short sale) + $400 (received from put) - $300 (paid for call)] Total cost to enter the market: -$10100 Result one: Disney stock rises (rallies) to $110 in July a) The put option sold expires worthless. (OTM) b) The call option purchased expires ITM. c) The trader exercises his or her right to buy 100 shares at $100, paying 10000 to the seller. d) The trader uses the 100 shares to cover the short sale. e) Trader gains a total of $100 after keeping the remainder of the credit earned when entering the market. [$10100 (credit) - $10000 (paid for shares] Result two: Disney stock falls to $90 in July. a) The call option purchased expires worthless. (OTM) b) The put option sold expires ITM. c) The investor who bought the trader's put option exercises his or her right to sell 100 shares at $100. The trader pays $10000 to the buyer, and receives 100 Disney shares. d) The trader uses the 100 shares to cover the short sale. e) The trader makes a total profit of $100 after keeping the remainder of the credit earned when entering the market. [$10100 (credit) - $10000 (paid to cover put)] Calculating The Risk Free Profit In A Reversal Strategy Investors earn instant profits when correctly entering a reversal trade. Market conditions will not matter at the time of expiration, as the synthetic long stock position covers losses and cancels gains on the short sale. In order to achieve instant profits, the price of the underlying asset must exceed the difference in premiums collected less the options' strike prices. [$100 = $100 (asset price) + $100 (premium credit) - $100 (options' strike prices)] Advantages and Disadvantages of Implementing a Reversal Strategy: Pluses: The upside to this type of strategy is that the investor will always make a small profit in any market situation, risk-free. The trader is just arbitraging the under priced options to fair market value. Minuses: There is no downside in carrying out a reversal strategy, since it risk-free. However, traders must be able to recognize under priced options of which values are lower than their associated underlying asset.
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Traders who implement a short box strategy are taking advantage of overpriced assets by instantly liquidating (arbitraging) them to fair market value. The technique involves selling both a bull call and bear put spread at the same time, using options with parallel strike prices and expirations. Traders can earn risk-free profit, as long as the credit received when entering the market exceeds the expiration value of the box. Moneyness Review for Puts and Calls Call Options: In-The-Money (ITM) = Strike price (less than) Market Price Out-of-The Money (OTM) = Strike price (more than) Market Price Put Options: In-The-Money (ITM) = Strike Price (more than) Market Price Out-of-The Money (OTM) = Strike Price (less than) Market Price Both Put and Call Options At-The-Money (ATM) Strike Price (equals) Market Price How To Set Up A Short Box Strategy Disney stock is worth $55 (market price) in July. Selling the Bull Call Spread 1) The trader writes (sells) a call option: DISAug50($7) - 100 shares of Disney stock - Strike Price $50 (ITM), expiring in 30 days - Premium Cost of $7 2) The trader buys a call option: DISAug60($1.50) - 100 shares of Disney stock - Strike Price $60 (OTM), expiring in 30 days - Premium Cost of $1.50 3) The trader receives a credit of $550 when entering the bull call spread. [$700 (received from call sale) - $150 (paid for call purchase)] Selling the Bear Put Spread 1) Trader writes (sells) a put option: DISAug60($7) - 100 shares of Disney stock - Strike Price $60 (ITM), expiring in 30 days - Premium Cost of $7 2) Trader buys a put option: DISAug50($2) - 100 shares of Disney stock - Strike Price $50 (OTM), expiring in 30 days - Premium Cost of $2 3) The trader receives a credit of $500 when entering the bear put spread. [$700 (received from put sale) - $200 (paid for put purchase)] Total (Short Box) credit when entering the market $1050: [$550 (credit from bull spread) + $500 (credit from bear spread)] Computing Expiration Value To earn risk-free profit, the credit received when entering the market must exceed the expiration value of the box. The expiration value is simply the difference between the higher and lower strike prices, multiplied by 100. This example's box spread expiration value is $1000 [$1000= $60 (high) - $50 (low) X 100], which is lower than the $1050 credit when entering the market. Result one: Disney stays at $55 (ATM) in August. a) Both the put and call options purchased expire worthless (OTM). b) The put option sold is ITM The buyer exercises his or her right to sell the trader 100 shares at $60. The trader pays $6000 to the seller. c) The call option sold is ITM. The buyer exercises his or her right to buy shares at $50 from the trader, who sells the 100 shares and receives $5000 from the buyer. d) The trader's profit is $50 after adding the credit received when entering the market from the loss. [$50 = $5000 (received from call buyer) - $6000 (paid to put buyer) + $1050 (credit)] Result two: Disney rallies to $60 in August. a) Both the put and call options purchased and the put option sold expire worthless (OTM). b) The call option sold is ITM. c) The trader buys 100 Disney shares in the open market to cover the sale, paying $6000. d) The buyer exercises his or her right to buy shares at $50 from the trader, who sells the 100 shares and receives $5000 from the buyer. e) The trader's profit is $50 after adding the credit received when entering the market from the loss. [$50 = $5000 (received from call buyer) - $6000 (paid for shares) + $1050 (credit)] Result three: Disney falls (crashes) to $50 in August. a) Both the put and call options purchased and the call option sold expire worthless (OTM). b) The put option sold is ITM. c) The buyer exercises his or her right to sell the trader 100 shares at $60. The trader pays $6000 to the seller. d) The trader sells 100 Disney shares in the open market at $50 and receives $5000. e) The trader's profit is $50 after adding the credit received when entering the market from the loss. [$50 = $5000 (received from put buyer) - $6000 (share sale) + $1050 (credit)] Advantages and Disadvantages of Implementing a Small Box Strategy: Pluses: The upside to this type of strategy is that the investor will always make a small profit in any market situation, risk-free. The trader is just arbitraging the overpriced options to fair market value. Minuses: There is no downside in carrying out a short strategy, since it risk-free. However, traders must be able to quickly recognize options with overpriced expiration values.
