34 lines
2.3 KiB
Plaintext
34 lines
2.3 KiB
Plaintext
Chapter 27: Arbitrage 423
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BASIC PUT AND CALL ARBITRAGE ("DISCOUNTING")
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The basic call and the basic put arbitrages are two of the simpler forms of option arbi
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trage. In these situations, the arbitrageur attempts to buy the option at a discount
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while simultaneously taking an opposite position in the underlying stock. He can then
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exercise his option immediately and make a profit equal to the amount of the discount.
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The basic call arbitrage is described first. This was also outlined in Chapter 1,
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under the section on anticipating exercise.
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Example: XYZ is trading at 58 and the XYZ July 50 call is trading at 7¾. The call is
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actually at a discount from parity of ¼ point. Discount options generally either are
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quite deeply in-the-money or have only a short time remaining until expiration, or
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both. The call arbitrage would be constructed by:
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1. buying the call at 7¾;
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2. selling the stock at 58;
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3. exercising the call to buy the stock at 50.
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The arbitrageur would make 8 points of profit from the stock, having sold it at 58 and
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bought it back at 50 via the option exercise. He loses the 7¾ points that he paid for
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the call option, but this still leaves him with an overall profit of¼ point. Since he is
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a member of the exchange, or is trading the seat of an exchange member, the arbi
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trageur pays only a small charge to transact the trades.
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In reality, the stock is not sold short per se, even though it is sold before it is
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bought. Rather, the position is designated, at the time of its inception, as an "irrevo
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cable exercise." The arbitrageur is promising to exercise the call. As a result, no
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uptick is required to sell the stock.
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The main goal in the call arbitrage is to be able to buy the call at a discount from
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the price at which the stock is sold. The differential is the profit potential of the arbi
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trage. The basic put arbitrage is quite similar to the call arbitrage. Again, the arbi
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trageur is looking to buy the put option at a discount from parity. The put arbitrage
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is completed with a stock purchase and option exercise.
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Example: XYZ is at 58 and the XYZ July 70 put is at 11 ¾. With the put at ¼ discount
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from parity, the arbitrageur might take the following action:
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1. Buy put at 11 ¾.
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2. Buy stock at 58.
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3. Exercise put to sell stock at 70. |