3 of my good friends and I started a small fund together, where we come up with ideas, trade and learn from each other (each of us is interested in something different when it comes to trading, and has different strategies). We have USD 13000 to invest with and I came up with an options arbitrage trade, which we have some questions about.
I found a company trading at exactly the strike price of 10, so I looked at its option chain and found an arbitrage opportunity as the bid-ask was 0.1 and 0.2 for calls. The bid-ask was 0.3 and 0.45 for puts. I decided to long a call, short a put and short 100 shares to be delta neutral.
This arbitrage would net us 10 cents per share. I wanted to figure out how much profit this would net us, if we decided to allocate USD 1000 to this trade. So, essentially, how many calls would I have to buy, puts that I would have to short and shares that I would have to short if I had a 1000 dollars for this particular strategy. Here is where I ran into my problem.
Obviously, we would make 10 dollars initially (giving 20 dollars for the call and receiving 30 dollars for the put), but how much money would be locking away for shorting 100 shares? My confusion stems from the fact that we are essentially borrowing 100 shares and selling them, so we are not actually using any cash in this transaction until we buy to cover.
Can anyone help me out?
I understand that this may seem like a very stupid question but go easy on me, I'm just a college sophomore. :)
You're saying that you the stock is trading at 10 and you can buy the strike 10 calls for 0.2 and sell the strike 10 puts for 0.3? It does not make sense that the delta 50 puts and calls trade at different prices due to put call parity. I'm guessing either you checked the option prices when the stock was trading slightly under 10 such that the put had intrinsic value (in which case you most likely have no arb), or the bid ask spread in the future was wide enough such that you would lose the 10 cents by selling the stock at bid price. Or you are not looking at the strike 10 calls and puts (maybe the 11 calls and puts, in which case you are essentially selling the future at 10 and buying the future at 11).
If it was an actual arb, it would be long gone now.
No, I checked all that. There was the arbitrage opportunity, but it went away in the first 2 hours of trading today. I found this opportunity yesterday afternoon around 3. It was trading at 10.01 so there isn't the intrinsic value and the strike prices vary by 2.5 so I wasn't looking at the wrong one.
I did check again yesterday night, by the way, so it wasn't something messed up from a 15 minute delay in price.
What's the dividend rate on the stock? Dividends decrease the value of a call and increase the value of a put. Highly, highly unlikely there was a real arb opportunity like that.
Also, were you looking at the bid-ask and taking the correct side for each leg of the option trade or were you looking at last trade?
You have to pay interest on the borrowed shares. You have to pay commissions on your stock purchase and on your purchase AND sale of options. You will have to pay commissions to eventually close the position. You will also have to put cash in a margin account to short puts. Arbitrage opportunity gone. Loss is guaranteed.
It is a very bad idea to try to do vol arb if you don't have advanced tech, access to vast amounts of capital and leverage, extremely cheap financing (only available to institutions) and expertise. Judging from your comment that you are using a platform with a 15 minute delay, you lack in all of these. You have more advanced knowledge than the average sophomore for sure, but it is highly dangerous for you to think you are in a position to arbitrage a vastly superior, more intelligent, lighting-fast market. For your own sake don't ever try to do this, no matter how good the opportunity seems. You will always lose.
Last I checked you need over 100k to sell naked options, so that might crimp future strategies
most arb houses do this with algos in fractions of a second, something this simple would be well and truly licked by the HFTers. Be really really careful that you've got your numbers right here.
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