Chapter 27: Arbitrage 425 
be able to use another in-the-money put. Suppose the XYZ July 80 put could be sold 
at 22. This would be the same as buying the stock at 58, because if the put were 
assigned, the arbitrageur would be forced to buy stock at 80 - the striking price - but 
his net cost would be 80 minus the 22 points he received from the sale of the put, for 
a net cost of 58. Again, the arbitrageur is able to use the sale of a deeply in-the-money 
option as a substitute for the stock trade. 
The examples above assumed that the arbitrageur sold a deeper in-the-money 
option at parity. In actual practice, if an in-the-money option is at a discount, an even 
deeper in-the-money option will generally be at a discount as well. The arbitrageur 
would normally try to sell, at parity, an option that was less deeply in-the-money than 
the one he is discounting. 
In a broader sense, this technique is applicable to any arbitrage that involves a 
stock trade as part of the arbitrage, except when the dividend in the stock itself is 
important. Thus, if the arbitrageur is having trouble buying or selling stock as part of 
his arbitrage, he can always check whether there is an in-the-money option that could 
be sold to produce a position equivalent to the stock position. 
DIVIDEND ARBITRAGE 
Dividend arbitrage is actually quite similar to the basic put arbitrage. The trader can 
lock in profits by buying both the stock and the put, then waiting to collect the divi­
dend on the underlying stock before exercising his put. In theory, on the day before 
a stock goes ex-dividend, all puts should have a time value premium at least as large 
as the dividend amount. This is true even for deeply in-the-money puts. 
Example: XYZ closes at 45 and is going to go ex-dividend by $1 tomorrow. Then a 
put with striking price of 50 should sell for at least 6 points ( the in-the-money amount 
plus the amount of the dividend), because the stock will go ex-dividend and is expect­
ed to open at 44, six points in-the-money. 
If, however, the put' s time value premium should be less than the amount of the 
dividend, the arbitrageur can take a riskless position. Suppose the XYZ July 50 put is 
selling for 5¾, with the stock at 45 and about to go ex-dividend by $1. The arbi­
trageur can take the following steps: 
1. Buy the put at 5¼. 
2. Buy the stock at 45. 
3. Hold the put and stock until the stock goes ex-dividend (1 point in this case). 
4. Exercise the put to sell the stock at 50.