Box Spread Arbitrage

Quote from jimmyjazz:

The day it occurred to me that a long call was essentially long stock with an "invisible" stop was a day my trading got a lot better. Indulge me, though -- do you try to account for sub-unity delta as well as slippage when comparing a long DITM call to long the underlying? It seems that in the example you gave you paid $11.00 ($1 extrinsic) but you didn't get 100 deltas, either.
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It for the most part is 100 delta if you account for the fact that one, my avg holding time might be weeks to a month. So the embedded put I'm long is simply being borrowed. In other words, when I go to sell the call, I'm also selling the embedded put at market prices. And two, if I'm right on my call, the put goes away and the delta goes to 100. Put another way, all variables are accounted for.
 
Hi Maverick,
Can you please explain in more detail how this is free money? Are you saying because the algo got a sale at the ask rather than at fair value of 2.20 by picking it off super fast milliseconds before the option bid ask had to change to 2.15 at 2.25 to accommodate the new price of XYZ and at which time one of the marketmakers asking 2.25 would have got the sale? If you don't mind, could you go into the mechanics of that?
Thanks.


Quote from Maverick74:

Options are all HFT now. In essence, the HFT's are doing what the floor guys use to do, they are just doing it much faster. Almost all Chicago option firms are market makers and more of the HFT variety.

I'll walk you through a real quick example. XYX is trading at $100. The Sept 100 calls are currently 2.25 at 2.35 let's say. Fair value is 2.30. There is 500 up on each side. When the stock ticks down to 99.80 an algo spots sitting order at 2.25. What "you" will see if you are watching it is the market changes to 2.20 at 2.35 with 500 on both sides but there is a little old 2 lot sitting at 2.25 still. That is a static limit order from mom and pop. It's not updating with the underlying. So the algo sees this and sees food. Now the stock returns to $100 and the market is 2.25 at 2.35 with 500 on both sides. But inside the 500 the algo now knows there is a 2 lot sitting there. That 2 lot is going to get picked off the second we see the stock move lower then 99.80. The problem is, to get that order you better be super fast because it's going to be free money. Sure enough the stock trades down to 99.60 and the market is now 2.15 at 2.25. That 2 lot is gone. It was picked off. To the naked eye you will not notice it unless you have the time and sales in front of you in which you will see the two lot print at 2.25. Otherwise it will look like the market just updated from 2.25 at 2.35 to 2.15 at 2.25 with 500 up.

These algos do this all day long and there is lot of free money there. A LOT! But algos are not putting on "calendar spreads" or "butterfly" spreads or box spreads, they are picking off orders. Guys on the floor did this for years. It was free money then and it's free money now, but you have to be fast. There really is no "trader" do this, it's all a machine. The people who work for these firms either program the algos or watch them and make sure smoke doesn't come out of the machine. It's pretty boring work. Hope this helps.
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Just when you think there's not much here at ET, along comes this. Straight to the point. Simple to understand, yet a wealth of what seems like, duh, why didn't I see that before. As I'm trying again for what seems the umpteenth time to trade options, this little tidbit is quote helpful. Thanks. The whole thread is helpful.

Quote from Maverick74:

The advantage is stops. When I buy an option vs stock, I'm paying for the right to defer my stop. We all value things differently. For me, the value of a stop is priceless. What I mean by that is, the right not to NOT get stopped out of a trade.

Example: XYZ is trading at $100. Let's say the stock is breaking out. The whole world see this of course but it's still a good trade. Say I buy 100 shares at $100 and put my stop order at 96.00. Now I'm not looking to flip this for 5 pts, I want to make 15 or 20 pts or more. But this is one volatile stock. So now I'm long at 100, it goes to 103 and a few days later some analysts mumbles something about valuation and downgrades the stock. I could give two shits what some guy at "our research is worthless, inc" thinks about valuation but it does pull the stock back to 95.00 over the next few days. I get stopped out at a 4 pt loss. Sure enough, that was the swing low and it rallies back up, takes out 103 and sure enough, goes to 120....130....140....150..etc.

The other scenario is, I buy the DITM call, say the 6 month 90 strike call for 11.00. There is no decay on this option. I'm basically long stock. My risk is 11.00 if the stock were to collapse, but I would probably get out at 5 or 6 pt loss. So now the stock pulls back to 95.00. I keep my call as it's still trading at 8.00. Stock then rallies to 110...120...130...140..etc. I get out at 120 lets say and sell my call for 30 pts that I paid 11 for.

So in this example, I purchased the right to not get stopped out of my trade. Technically that right cost me 1.00 over 6 months. Or about two cents a day. Sure, one could say I bought the call for the leverage, but that is not how I price this opportunity. I price the value of the stop. You have to understand no matter what you are trading, the market is very messy these days. Even the BEST trades are going to shake you out. Look what TSLA did before it shot to 155. That was cruel. But that is what the market does today.

Now before you say, well if I get stopped out I'll just get back in. Well, how many times are you going to do that? Twice, three times, 5 times? Trust me, the market will take you out 5 times and then double. It's called murphy's law. You'll lose 5 times what your original stop was and still won't catch the move.

It's all about choice and what you value. I value not getting stopped out. My calls tend to be good. I do obscene amounts of spreadsheet work to get into the right trades and I trust my decisions. What I don't trust is the noise to follow. I can't control the rumors, the upgrades, downgrades, the chatter on CNBC, the rumors that some hedge fund is putting out there. However I also don't want to say "f*ck it" and not use a stop. That's how guys go from trading into selling used cars.

At the end of the day you have to make a choice. Nothing is free. You have to decide what you want and what you are willing to give up to get that. It's no different then any other decision you make in life.
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Referring to what Mav was saying, I might be better off just looking at DITM calls with my trades.

I was wondering this also, if someone can really real level 2 while trading stocks, is it possible to read the level 2 and prints of option trades and make money or would it be kind of a waste since theoretically the stocks will move first vs the options?
 
Quote from chicagodon:

Referring to what Mav was saying, I might be better off just looking at DITM calls with my trades.

I was wondering this also, if someone can really real level 2 while trading stocks, is it possible to read the level 2 and prints of option trades and make money or would it be kind of a waste since theoretically the stocks will move first vs the options?
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Don't lose sight of the forest through the trees. Level 2 hasn't been useful since 1999.
 
Quote from chicagodon:

Referring to what Mav was saying, I might be better off just looking at DITM calls with my trades.

I was wondering this also, if someone can really real level 2 while trading stocks, is it possible to read the level 2 and prints of option trades and make money or would it be kind of a waste since theoretically the stocks will move first vs the options?
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What do DITM calls have to do with trading a box? No, LVL2 will not be of use. Please re-read Maverick's post.
 
Quote from drownpruf:

What do DITM calls have to do with trading a box? No, LVL2 will not be of use. Please re-read Maverick's post.
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Nothing, the box question was answere by post 3 of the thread, I just didn't want to start a new thread.
 
As usual Mav is making some great points here, for simple trading you can look at options as a stock substitute. How many deltas would you like today 10, 50, 500, 5000, etc. So ChicagoDon you are long 25 deltas on your first spread. Therefore, you will make/lose 25 for each point, if you take the other greeks out for now and keep it simple (no theta, gamma or vega risk) you are long roughly 25 shares of GMCR, GMCR was down 2.50 today so 2.50 x .25 = .6250 so that is how much you are down end of day. Remember your basic synthetics, 100 shares of stock is roughly two at the money calls that are 50 delta ie 100 deltas. One of the problems is that people are at different points in their trading in terms of knowledge and strategy. You should understand basic synthetics, Cottle's book is good but you are at the deep end of the pool pretty quickly. Alot of people have gotten very rich understanding u = c- p


http://www.wilmott.com/blogs/collector/index.cfm/2006/6/21/The-Discovery-of-PutCall-Parity
 
Quote from kinggyppo:

As usual Mav is making some great points here, for simple trading you can look at options as a stock substitute. How many deltas would you like today 10, 50, 500, 5000, etc. So ChicagoDon you are long 25 deltas on your first spread. Therefore, you will make/lose 25 for each point, if you take the other greeks out for now and keep it simple (no theta, gamma or vega risk) you are long roughly 25 shares of GMCR, GMCR was down 2.50 today so 2.50 x .25 = .6250 so that is how much you are down end of day. Remember your basic synthetics, 100 shares of stock is roughly two at the money calls that are 50 delta ie 100 deltas. One of the problems is that people are at different points in their trading in terms of knowledge and strategy. You should understand basic synthetics, Cottle's book is good but you are at the deep end of the pool pretty quickly. Alot of people have gotten very rich understanding u = c- p


http://www.wilmott.com/blogs/collector/index.cfm/2006/6/21/The-Discovery-of-PutCall-Parity
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Thank you, I completely agree with what your said. I calculated the delta ratio and saw that it was only around .25 which was lower then it probably should be, I have 5 though. I'm going to study more about synthetics this weekend.

I feel like I read Cottle and Nattenburg and understand it well, but practicality it's entirely different. Thanks for the link, I went back to Cottles arbitrage chapter and thumbed through it again. Are these types of call parity trades even available anymore? Meaning I assume someone has written an algo already to spot the arbitrage and execute it before I could even move my mouse. If not, I would assume to make it worth the retailer trader it would have to be pretty large to be able to cover all the costs associated with doing this. Again I could be completely off and I value everyone's help as I'm very new to options trading.
 
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