36 lines
2.7 KiB
Plaintext
36 lines
2.7 KiB
Plaintext
Chapter 27: Arbitrage 443
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arbitrage with the box spread. It can be evaluated at a glance. Only two questions
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need to be answered:
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1. If one were to establish a debit call spread and a debit put spread, using the same
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strikes, would the total cost be less than the difference in the striking prices plus
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carrying costs? If the answer is yes, an arbitrage exists.
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2. Alternatively, if one were to sell both spreads - establishing a credit call spread
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and a credit put spread - would the total credit received plus interest earned be
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greater than the difference in the striking prices? If the answer is yes, an arbi
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trage exists.
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There are some risks to box arbitrage. Many of them are the same as those risks
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faced by the arbitrageur doing conversions or reversals. First, there is risk that the
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stock might close at either of the two strikes. This presents the arbitrageur with the
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same dilemma regarding whether or not to exercise his long options, since he is not
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sure whether he will be assigned. Additionally, early assignment may change the prof
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itability: Assignment of a short put will incur large carrying costs on the resulting long
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stock; assignment of a short call will inevitably come just before an ex-dividend date,
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costing the arbitrageur the amount of the dividend.
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There are not many opportunities to actually transact box arbitrage, but the fact
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that such arbitrage exists can help to keep markets in line. For example, if an under
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lying stock begins to move quickly and order flow increases dramatically, the special
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ist or market-markers in that stock's options may be so inundated with orders that
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they cannot be sure that their markets are correct. They can use the principles of box
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arbitrage to keep prices in line. The most active options would be the ones at strikes
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nearest to the current stock price. The specialist can quickly add up the markets of
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the call and put at the nearest strike above the stock price and add to that the mar
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kets of the options at the strike just below. The sum of the four should add up to a
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price that surrounds the difference in the strikes. If the strikes are 5 points apart,
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then the sum of the four markets should be something like 4½ bid, 5½ asked. If,
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instead, the four markets add up to a price that allows box arbitrage to be established,
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then the specialist will adjust his markets.
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VARIATIONS ON EQUIVALENCE ARBITRAGE
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Other variations of arbitrage on equivalent positions are possible, although they are
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relatively complicated and probably not worth the arbitrageur's time to analyze. For
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example, one could buy a butterfly spread with calls and simultaneously sell a but
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terfly spread using puts. A listed straddle could be sold and a synthetic straddle |