Do arbitrage opportunities exist for retail investors?
- Thread starter Victory5
- Start date
It's nonsense to claim that "stat arb" means "pairs trading."
Pick a market. You estimate vol to be 20% sampled close-close. You estimate vol to be 10% sampled hourly. Based on your stats (estimates), there is an arbitrage. It's only as risk free as your stats are flawless and a given (that is, not at all). But there may be edge.
So you sell the ATM straddle and delta hedge close-close, while also buying the ATM straddle and hedging hourly. Net net, no options at all, just a net delta hedging strategy in ONE underlying.
Stat arb gets its name from imposing a distribution on a market and basically pretending that's the real world. It's first moment arb -- a coin flip with expected P&L >= 0. But all good trades start with a positive expected P&L. You still have to have a good model to derive said distribution and be able to contain variance. It's not risk free, but if you stay alive and don't blow up then the central limit theorem says you should make money over time.
Pick a market. You estimate vol to be 20% sampled close-close. You estimate vol to be 10% sampled hourly. Based on your stats (estimates), there is an arbitrage. It's only as risk free as your stats are flawless and a given (that is, not at all). But there may be edge.
So you sell the ATM straddle and delta hedge close-close, while also buying the ATM straddle and hedging hourly. Net net, no options at all, just a net delta hedging strategy in ONE underlying.
Stat arb gets its name from imposing a distribution on a market and basically pretending that's the real world. It's first moment arb -- a coin flip with expected P&L >= 0. But all good trades start with a positive expected P&L. You still have to have a good model to derive said distribution and be able to contain variance. It's not risk free, but if you stay alive and don't blow up then the central limit theorem says you should make money over time.
surf, the people that are telling you that pairs trading is a subset of stat arb are correct. Although, it is in one sense the same: In both cases, you are trading one thing against another (although be careful, it doens't have to be another instrument. For example, theta against gamma in options trading). I think that is what you meant.
Easy mistake to make.
We can let the readers decide who made the stupid comment (not including your sock puppets lol).
you may also consider capital structure arbitrage. If a company has both common and preferred stocks issued and if your trading platform allows trading preferred then you could set up an auto-trader to leg-in at specific spread price levels. Or you could do this manually but it's a bit more work. The way it's done is you enter on a limit order for the low-volume stock and hedge at the market on a high-volume stock. Examples are LEN, LEN.B, DISCA DISCB etc. A good assumption to have is that this space is extremely crowded and your best bet is to take trades at extremes.
Risk arb or merger arb is another form that is probably available to retail investors. I wouldn't advise doing it "the right way" as there were too many blown accounts due to mergers not going through. For this reason it's probably wiser to bet against the merger right before its completion. You put the spread backwards in anticipation that it will blow up. If it doesn't then your loss is controlled.
Finally, pair trading is another strategy worth exploring but only if you have access to capital/leverage, can hold overnight and instead of pure arb can settle for market neutrality and full or partial trade automation.
Risk arb or merger arb is another form that is probably available to retail investors. I wouldn't advise doing it "the right way" as there were too many blown accounts due to mergers not going through. For this reason it's probably wiser to bet against the merger right before its completion. You put the spread backwards in anticipation that it will blow up. If it doesn't then your loss is controlled.
Finally, pair trading is another strategy worth exploring but only if you have access to capital/leverage, can hold overnight and instead of pure arb can settle for market neutrality and full or partial trade automation.