SPX / SPY Options Arbitrage?

Quote from FullyArticulate:

Think about this from the other side of your transaction.

Lets use your values for SPY:

Sell 10 SPY (142.28) Dec 09 190 puts at 47.80

So, you're the guy who bought these SPY puts for essentially $.08. The next dividend coming up for SPY is in March and will likely be about $.55. After the dividend, SPY immediately drops $.55.

So, you hold the stock through div-ex, pocket the $.55 dividend and exercise your puts. You will have made $.55 - $.08 (x100x10)

The guy who sold the option now owns a stock that's worth $.55 less than it was a day ago. He can sell another 190 put and sell the stock, but he will have lost the bid/ask on the option and .55 on the stock.

Wash, rinse, repeat for the next 3 years.

It is possible for you to make more than the risk free rate on your short puts if the buyer of your puts isn't optimally exercising. There are dozens of academic papers on this.

I hope that helps a little. Just look at the transaction from the other side to see what will happen.
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Good Point. Perhaps the best strategy is to deal with SPY puts that have some more time value. Then, if your broker will consider them "covered," your rate of return gets more interesting.

AZD
 
Quote from arizonadreamer:

Good Point. Perhaps the best strategy is to deal with SPY puts that have some more time value.
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They need to have at least the dividend amount in time value, or else you're guaranteed to be exercised.

Your margin issue is an interesting one, but what happens if you get assigned. Even if your broker will make the SPX/SPY margin free (which won't happen), you may suddenly need margin on $140,000 in stock if you get assigned on your 10 puts.

You'll then need to convince your broker that your synthetic call shouldn't actually count as stock margin.

Either way, the broker is going to be out the cash to pay for your stock. If you sell 100 of these because they're "Free" margin-wise, your broker is still going to have to fork over $1.4M in cash if you're assigned.

And, all of THAT ignores the risk-free-rate which is pretty critical.
 
To throw something else in the mix, you have IVV as well, which trades closely to SPY. Not suggesting anything, just saying that it would be something else you can look into as well.
 
arizonadreamer,

Consider this. Buying SPX 1900 put at 318 means $31,800 in cash gets tied up in the trade for 1059 days. The lost interest on that amount is $4,844 (31,800*0.0525*1059/365). I bet you forgot about that!

But, hey, who are we to tell you otherwise, if you think it'll work then go for it! Report back in 3 years!:D
 
Quote from MTE:

arizonadreamer,

Consider this. Buying SPX 1900 put at 318 means $31,800 in cash gets tied up in the trade for 1059 days. The lost interest on that amount is $4,844 (31,800*0.0525*1059/365). I bet you forgot about that!

But, hey, who are we to tell you otherwise, if you think it'll work then go for it! Report back in 3 years!:D
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MTE,

Thanks for the input. No, I did not forget about that. And I just used that particular month/strike as an example. It is possible to get a big discount on 1 and 2 year contracts as well.

Also, the position could be closed out at any time, so a 3 year (or 1 year) wait would not necessarily be the case.

Thanks again for the input.

AZD
 
Quote from FullyArticulate:

They need to have at least the dividend amount in time value, or else you're guaranteed to be exercised.

Your margin issue is an interesting one, but what happens if you get assigned. Even if your broker will make the SPX/SPY margin free (which won't happen), you may suddenly need margin on $140,000 in stock if you get assigned on your 10 puts.

You'll then need to convince your broker that your synthetic call shouldn't actually count as stock margin.

Either way, the broker is going to be out the cash to pay for your stock. If you sell 100 of these because they're "Free" margin-wise, your broker is still going to have to fork over $1.4M in cash if you're assigned.

And, all of THAT ignores the risk-free-rate which is pretty critical.
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FA,

Thanks for your input. It seems the big key in this is to get your broker to allow you to set up the position "free" with no naked requirements on the puts.

I'm not necessarily going to do one of these, but it's always nice to investigate all scenarios, even if they seem too good to be true.

Thanks again for your help.

AZD
 
Quote from arizonadreamer:

MTE,

Thanks for the input. No, I did not forget about that. And I just used that particular month/strike as an example. It is possible to get a big discount on 1 and 2 year contracts as well.

Also, the position could be closed out at any time, so a 3 year (or 1 year) wait would not necessarily be the case.

Thanks again for the input.

AZD
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As I said before, the discount is the nature of pricing European-style put options. As they get closer to expiry the discount decreases, eventually they get to parity. This is not a mispricing! It is the way European-style options are priced!
 
Quote from MTE:

As I said before, the discount is the nature of pricing European-style put options. As they get closer to expiry the discount decreases, eventually they get to parity. This is not a mispricing! It is the way European-style options are priced!
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I have realized all along this is the way they are priced. It's called backwardation, I believe. Just looking for opportunities . . . . and they do exist.

AZD
 
What happens to your position if volatility drops dramatically?

(Use an option calculator that can do American as well as European pricing)

The short American put will never drop below its intrinsic value, but the bottom will fall out from below the European put and, if all other factors stay the same, will take a long time to crawl back upwards.

In the meantime, your broker will place a large margin call, and your strategy will need to be amended. And this is only one of several risk-holes that could swallow you.

Do a thorough analysis, become a professional trader with haircut margin, run simulations, and then go for it...
 
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