37 lines
2.8 KiB
Plaintext
37 lines
2.8 KiB
Plaintext
Chapter 27: Arbitrage 433
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available in the marketplace at a net profit of ½ point, or 50 cents. Such a reversal
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may not be equally attractive to all arbitrageurs. Those who have "box" stock may be
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willing to do the reversal for 50 cents; those who have to pay 1 % to borrow stock may
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want 0.55 for the reversal; and those who pay 2% to borrow stock may need 0.65 for
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the reversal. Thus, arbitrageurs who do conversions and reversals are in competition
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with each other not only in the marketplace, but in the stock loan arena as well.
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Reversals are generally easier positions for the arbitrageur to locate than are
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conversions. This is because the fixed cost of the conversion has a rather burdensome
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effect. Only if the stock pays a rather large dividend that outweighs the carrying cost
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could the fixed portion of the conversion formula ever be a profit as opposed to a
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cost. In practice, the interest rate paid to carry stock is probably higher than the
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interest earned from being short stock, but any reasonable computer program should
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be able to handle two different interest rates.
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The novice trader may find the term "conversion" somewhat illogical. In the
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over-the-counter option markets, the dealers create a position similar to the one
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shown here as a result of actually converting a put to a call.
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Example: When someone owns a conventional put on XYZ with a striking price of
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60 and the stock falls to 50, there is often little chance of being able to sell the put
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profitably in the secondary market. The over-the-counter option dealer might offer
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to convert the put into a call. To do this, he would buy the put from the holder, then
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buy the stock itself, and then offer a call at the original striking price of 60 to the
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holder of the put. Thus, the dealer would be long the stock, long the put, and short
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the call - a conversion. The customer would then own a call on XYZ with a striking
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price of 60, due to expire on the same date that the put was destined to. The put
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that the customer owned has been converted into a call. To effect this conversion,
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the dealer pays out to the customer the difference between the current stock price,
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50, and the striking price, 60. Thus, the customer receives $1,000 for this conver
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sion. Also, the dealer would charge the customer for costs to carry the stock, so that
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the dealer had no risk. If the stock rallied back above 60, the customer could make
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more money, because he owns the call. The dealer has no risk, as he has an arbitrage
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position to begin with. In a similar manner, the dealer can effect a reverse conver
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sion - converting a call to a put - but will charge the dividends to the customer for
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doing so.
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RISKS IN CONVERSIONS AND REVERSALS
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Conversions and reversals are generally considered to be riskless arbitrage. That is,
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the profit in the arbitrage is fixed from the start and the subsequent movement of the |