Hi guys,
I recently noticed a really strange put-call parity on a volatile pharmaceutical (ARNA crashed right before close, someone had probably GTC ITM call that reflected the pricing of ARNA before it crashed but forgot to cancel it when ARNA went down) that last for a couple of minutes, where one would have made big money if he/she traded the box spread on it.
This led me to look into box spread arbitrage; now, earlier threads here and other various sources such as Wikipedia all claim that box spread arbitrage opportunities are slim, profits are negligible (eaten up by transaction costs).
But when you look at almost any liquid stock's option chain,
if I could execute my short call's and put's at the maximum of the last trade and the half-way past the mid-point bid/ask (say the bid/ask if 5.10 and 5.25, I improve the asking price by moving it to 5.22);
and if I could execute my long call's and put's at the minimum of the last trade and the half-way past the mid-point bid/ask.
Almost in all cases, you net a profit of $10-30/contract (see GOOG September box spread at 260-270; if you 260 short call's, 270 long call's, 270 short put's, 260 long put's were executed at the price respectively of 5.22, 0.84, 7.57, 1.80); same example is reflected in the case of ARNA September box spread at 7-8.
Now, taking into consideration of transaction costs, IB charges $0.75/contract, or $3.75/contract so if I could make an average profit at around $15/profit, then TC is not an issue. Also for margin requirements, I calculated it roughly for you profit to be a return of 1% to 3% of your collateral (e.g., to make $150, you will need to put down $10,150 on 1.4% return).
This doesn't seem very much return, but if you do this type of box trading right before option expiration, then you only need to hold onto your box for a couple of days for the return. Now, with CBOE introducing weeklies, you could potentially do this on a weekly basis.
But there's still some risks such as assignment risk, but my thinking is if I don't trade options with underlying equity that pays out dividend; even if I get assigned (let's say stock goes up and my ITM calls gets assigned), my counter-option position, my other long call and short put would also moved to would balance my P/L out.
Finally, there's execution risk. Market makers can do this day in and day out because they have low transaction cost and could modify/cancel their quotes the fastest. How can I get my orders executed in front of the market maker?
My thinking here is that I'll use IB's combo trader to submbit a multi-leg order to the market. To be honest, I'm not sure how IB's smart-router is going to execute this type of order but as I understand it: on ISE, it perform some kind of multi-leg matching and on other options exchange, if my orders hit the market bid or ask, it gets executed; otherwise, it remains a hidden order until someone else improves the price in my favor and IB will execute that leg for me. However, the multi-leg order has to have the same number of its legs executed, ensuring my box spread.
I will have a option quote stream running throughout the day and pragmatically modify/cancel the pricing my combo order (to the pricing model I described above) as the option pricing bid/ask changes. On IB's fees/commissions page, it states that cancel/modify fees are not applied to combo orders (I'm not sure if this is also the case with pass-through exchange cancel/modify fees). So assuming that this is true, I could modify/cancel all day long with out penalty like a market-maker, until I get my box spread order filled.
This is my thinking. I apologize for the long post, but I wanted people to poke holes in my strategy as the saying goes, "if it's too good to be true, it probably is."
I recently noticed a really strange put-call parity on a volatile pharmaceutical (ARNA crashed right before close, someone had probably GTC ITM call that reflected the pricing of ARNA before it crashed but forgot to cancel it when ARNA went down) that last for a couple of minutes, where one would have made big money if he/she traded the box spread on it.
This led me to look into box spread arbitrage; now, earlier threads here and other various sources such as Wikipedia all claim that box spread arbitrage opportunities are slim, profits are negligible (eaten up by transaction costs).
But when you look at almost any liquid stock's option chain,
if I could execute my short call's and put's at the maximum of the last trade and the half-way past the mid-point bid/ask (say the bid/ask if 5.10 and 5.25, I improve the asking price by moving it to 5.22);
and if I could execute my long call's and put's at the minimum of the last trade and the half-way past the mid-point bid/ask.
Almost in all cases, you net a profit of $10-30/contract (see GOOG September box spread at 260-270; if you 260 short call's, 270 long call's, 270 short put's, 260 long put's were executed at the price respectively of 5.22, 0.84, 7.57, 1.80); same example is reflected in the case of ARNA September box spread at 7-8.
Now, taking into consideration of transaction costs, IB charges $0.75/contract, or $3.75/contract so if I could make an average profit at around $15/profit, then TC is not an issue. Also for margin requirements, I calculated it roughly for you profit to be a return of 1% to 3% of your collateral (e.g., to make $150, you will need to put down $10,150 on 1.4% return).
This doesn't seem very much return, but if you do this type of box trading right before option expiration, then you only need to hold onto your box for a couple of days for the return. Now, with CBOE introducing weeklies, you could potentially do this on a weekly basis.
But there's still some risks such as assignment risk, but my thinking is if I don't trade options with underlying equity that pays out dividend; even if I get assigned (let's say stock goes up and my ITM calls gets assigned), my counter-option position, my other long call and short put would also moved to would balance my P/L out.
Finally, there's execution risk. Market makers can do this day in and day out because they have low transaction cost and could modify/cancel their quotes the fastest. How can I get my orders executed in front of the market maker?
My thinking here is that I'll use IB's combo trader to submbit a multi-leg order to the market. To be honest, I'm not sure how IB's smart-router is going to execute this type of order but as I understand it: on ISE, it perform some kind of multi-leg matching and on other options exchange, if my orders hit the market bid or ask, it gets executed; otherwise, it remains a hidden order until someone else improves the price in my favor and IB will execute that leg for me. However, the multi-leg order has to have the same number of its legs executed, ensuring my box spread.
I will have a option quote stream running throughout the day and pragmatically modify/cancel the pricing my combo order (to the pricing model I described above) as the option pricing bid/ask changes. On IB's fees/commissions page, it states that cancel/modify fees are not applied to combo orders (I'm not sure if this is also the case with pass-through exchange cancel/modify fees). So assuming that this is true, I could modify/cancel all day long with out penalty like a market-maker, until I get my box spread order filled.
This is my thinking. I apologize for the long post, but I wanted people to poke holes in my strategy as the saying goes, "if it's too good to be true, it probably is."
