38 lines
3.1 KiB
Plaintext
38 lines
3.1 KiB
Plaintext
424 Part IV: Additional Considerations
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The stock transaction is a 12-point profit, since the stock was bought at 58 and is sold
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at 70 via the put exercise. The cost of the put - 11 ¾ points - is lost, but the arbi
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trageur still makes ¼-point profit. Again, this profit is equal to the arrwunt of the dis
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count in the option when the position was established. Generally, the arbitrageur
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would exercise his put option immediately, because he would not want to tie up his
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capital to carry the long stock. An exception to this would be if the stock were about
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to go ex-dividend. Dividend arbitrage is discussed in the next section.
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The basic call and put arbitrages may exist at any time, although they will be
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more frequent when there is an abundance of deeply in-the-money options or when
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there is a very short time remaining until expiration. After market rallies, the call
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arbitrage may be easier to establish; after market declines, the put arbitrage will be
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easier to find. As an expiration date draws near, an option that is even slightly in-the
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money on the last day or two of trading could be a candidate for discount arbitrage.
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The reason that this is true is that public buying interest in the option will normally
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wane. The only public buyers would be those who are short and want to cover. Many
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covered writers will elect to let the stock be called away, so that will reduce even fur
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ther the buying potential of the public. This leaves it to the arbitrageurs to supply the
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buying interest.
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The arbitrageur obviously wants to establish these positions in as large a size as
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possible, since there is no risk in the position if it is established at a discount. Usually,
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there will be a larger market for the stock than there will be for the options, so the
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arbitrageur spends more of his time on the option position. However, there may be
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occasions when the option markets are larger than the corresponding stock quotes.
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When this happens, the arbitrageur has an alternative available to him: He might sell
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an in-the-money option at parity rather than take a stock position.
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Example: XYZ is at 58 and the XYZ July 50 call is at 7¾. These are the same figures
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as in the previous example. Furthermore, suppose that the trader is able to buy more
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options at 7¾ than he is able to sell stock at 58. If there were another in-the-money
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call that could be sold at parity, it could be used in place of the stock sale. For exam
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ple, if the XYZ July 40 call could be sold at 18 (parity), the arbitrage could still be
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established. Ifhe is assigned on the July 40 that he is short, he will then be short stock
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at a net price of 58 - the striking price of 40, plus the 18 points that were brought in
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from the sale of the July 40 call. Thus, the sale of the in-the-money call at parity is
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equivalent to shorting the stock for the arbitrage purpose.
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In a similar manner, an in-the-money put can be used in the basic put arbitrage.
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Example: With XYZ at 58 and the July 70 put at 11¾, the arbitrage could be estab
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lished. However, if the trader is having trouble buying enough stock at 58, he might |