34 lines
2.4 KiB
Plaintext
34 lines
2.4 KiB
Plaintext
428 Part IV: Additional Considerations
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going ex-dividend on the following day. Since he must sell the stock to set up the arbi
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trage, he cannot afford to wind up the day being short any stock, for he will then have
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to pay out the dividend the following day (the ex-dividend date). Furthermore, his
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records must be accurate, so that he exercises all his long options on the day before
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the ex-dividend date. If the arbitrageur is careless and is still short some stock on the
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ex-date, he may find that the dividend he has to pay out wipes out a large portion of
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the discount profits he has established.
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CONVERSIONS AND REVERSALS
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In the introductory material on puts, it was shown that put and call prices are relat
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ed through a process known as conversion. This is an arbitrage process whereby a
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trader may sometimes be able to lock in a profit at absolutely no risk. A conversion
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consists of buying the underlying stock, and also buying a put option and selling a
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call option such that both options have the same terms. This position will have a
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locked-in profit if the total cost of the position is less than the striking price of the
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options.
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Example: The following prices exist:
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XYZ common, 55;
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XYZ January 50 call, 6½; and
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XYZ January 50 put, 1.
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The total cost of this conversion is 49½ - 55 for the stock, plus 1 for the put, less 6½
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for the call. Since 49½ is less than the striking price of 50, there is a locked-in profit
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on this position. To see that such a profit exists, suppose the stock is somewhere
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above 50 at expiration. It makes no difference how far above 50 the stock might be;
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the result will be the same. With the stock above 50, the call will be assigned and the
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stock will be sold at a price of 50. The put will expire worthless. Thus, the profit is½
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point, since the initial cost of the position was 49½ and it can eventually be liquidat
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ed for a price of 50 at expiration. A similar result occurs if XYZ is below 50 at expi
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ration. In this case, the trader would exercise his put to sell his stock at 50, and the
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call would expire worthless. Again, the position is liquidated for a price of 50 and,
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since it only cost 49½ to establish, the same ½-point profit can be made. No matter
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where the stock is at expiration, this position has a locked-in-profit of½ point.
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This example is rather simplistic because it does not include two very important
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factors: the possible dividend paid by the stock and the cost of carrying the position |