37 lines
3.0 KiB
Plaintext
37 lines
3.0 KiB
Plaintext
426 Part IV: Additional Considerations
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The trader makes 5 points from the stock trade, buying it at 45 and selling it at 50 via
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the put exercise, and also collects the I-point dividend, for a total inflow of 6 points.
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Since he loses the 5¾ points he paid for the put, his net profit is ¼ point.
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Far in advance of the ex-dividend date, a deeply in-the-money put may trade
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very close to parity. Thus, it would seem that the arbitrageur could "load up" on these
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types of positions and merely sit back and wait for the stock to go ex-dividend. There
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is a flaw in this line of thinking, however, because the arbitrageur has a carrying cost
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for the rrwney that he must tie up in the long stock. This carrying cost fluctuates with
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short-term interest rates.
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Example: If the current rate of carrying charges were 6% annually, this would be
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equivalent to 1 % every 2 months. If the arbitrageur were to establish this example
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position 2 months prior to expiration, he would have a carrying cost of .5075 point.
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(His total outlay is 50¾ points, 45 for the stock and 5¾ for the options, and he would
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pay 1 % to carry that stock and option for the two months until the ex-dividend date.)
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This is more than ½ point in costs - clearly more than the ¼-point potential profit.
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Consequently, the arbitrageur must be aware of his carrying costs if he attempts to
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establish a dividend arbitrage well in advance of the ex-dividend date. Of course, if
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the ex-dividend date is only a short time away, the carrying cost has little effect, and
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the arbitrageur can gauge the profitability of his position mostly by the amount of the
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dividend and the time value premium in the put option.
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The arbitrageur should note that this strategy of buying the put and buying the
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stock to pick up the dividend might have a residual, rather profitable side effect. If
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the underlying stock should rally up to or above the striking price of the put, there
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could be rather large profits in this position. Although it is not likely that such a rally
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could occur, it would be an added benefit if it did. Even a rather small rally might
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cause the put to pick up some time premium, allowing the arbitrageur to trade out
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his position for a profit larger than he could have made by the arbitrage discount.
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This form of arbitrage occasionally lends itself to a limited form of risk arbi
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trage. Risk arbitrage is a strategy that is designed to lock in a profit if a certain event
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occurs. If that event does not occur, there could be a loss (usually quite limited);
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hence, the position has risk. This risk element differentiates a risk arbitrage from a
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standard, no-risk arbitrage. Risk arbitrage is described more fully in a later section,
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but the following example concerning a special dividend is one form of risk arbitrage.
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Example: XYZ has been known to declare extra, or special, dividends with a fair
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amount of regularity. There are several stocks that do so - Eastman Kodak and
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General Motors, for example. In this case, assume that a hypothetical stock, XYZ, has |