Let me start by saying that I *DONT* think Ive found a magical risk-free money-making strategy. Ive found something that looks like an arbitrage opportunity to my non-expert eye, and Im posting here for more experienced folk to tell me why it wont work.
Theres a stock Ive been watching/trading, sometimes just buying & selling the stock, sometimes writing covered calls near expiration.
I considered buying the stock Thursday, but was nervous about the market overall and did not pull the trigger. That was fortunate for me because the stock declined further on Friday.
Near the close on Friday with the stock down substantially, I considered going long again, and decided to look at the stocks option chain. I noticed that the price of put options a few months out seemed very expensive to me, and decided that instead of buying the stock outright, I would sell-to-open near-the-money puts with the hope of either pocketing the premium or picking up the stock at a substantial discount to the already depressed price. I executed the trade - I simply hit the bid price because I didnt want to mess around trying to get filled in between the spread, and the price seemed like such a good deal to me that I just wanted to make sure I got filled.
OK, nothing unusual so far - Ive done this before when I was bullish on a stock but wasnt really hoping for a quick upward swing.
Then I looked at the call prices and I became very surprised. It looked like the call prices were very cheap compared to the puts - so much so that I could establish a synthetic long position at a significant discount to the stock price, even if I just ate the cost of the bid/ask spread on both legs.
By the time I figured this out it was after the close, and at any rate I wasnt confident of what I was seeing. Anyway I was happy with the position I had established and decided to just do some research and determine whether what I was seeing was real or a dangerous mirage.
I found a helpful article:
http://www.optionetics.com/market/articles/23780
containing this excerpt:
---------------------------------
In this day and age the expression âThereâs no free lunch on Wall Streetâ is more omnipresent than ever. With the sophistication of the market as it is, youâre unlikely to see this sort of arbitrage gem without a prevalent fishy aroma in the air.
When would you come across this type of âlook, but donât touchâ situation? This kind of pricing is most evident when a trader has inadvertently come across an underlying market which is hard-to-borrow [HTB] for shorting shares or maybe just a very thinly and loosely traded product. Either way, itâs best to be highly skeptical first before you consider placing your order.
In a situation where shares are âHTBâ or impossible to short; calls can trade at a theoretical discount to puts. The reason is the natural hedge to reduce delta or directional risk with short stock is either very tricky business or altogether, not a viable option, pardon the pun. This means the yummy looking value meal isnât the same opportunity offered as part of a regular conversion / reversal market.
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So that makes sense to me, and had occurred to me already: that if the stock is very hard to short, then I cant easily establish a true arbitrage trade by selling the stock and buying calls. But it still seems bizarre and surprising to me that I seem to be able to exploit the put pricing to take on a simulated long position at a very significant discount to the current stock price (significant enough to vastly outweigh commission costs).
Ive looked at other option chains and its a little hard to evaluate them because the market is closed so Im not sure Im seeing option prices that are actually parallel to the stock price, but it looks like there are some disparities around - not quite as big as what I found but big enough that if you wanted to buy the stock anyway (or wanted to liquidate a short position) you would be much better off going the synthetic route.
What am I missing? What should I be wary of?
Thanks for any insight or warnings you can provide...
Theres a stock Ive been watching/trading, sometimes just buying & selling the stock, sometimes writing covered calls near expiration.
I considered buying the stock Thursday, but was nervous about the market overall and did not pull the trigger. That was fortunate for me because the stock declined further on Friday.
Near the close on Friday with the stock down substantially, I considered going long again, and decided to look at the stocks option chain. I noticed that the price of put options a few months out seemed very expensive to me, and decided that instead of buying the stock outright, I would sell-to-open near-the-money puts with the hope of either pocketing the premium or picking up the stock at a substantial discount to the already depressed price. I executed the trade - I simply hit the bid price because I didnt want to mess around trying to get filled in between the spread, and the price seemed like such a good deal to me that I just wanted to make sure I got filled.
OK, nothing unusual so far - Ive done this before when I was bullish on a stock but wasnt really hoping for a quick upward swing.
Then I looked at the call prices and I became very surprised. It looked like the call prices were very cheap compared to the puts - so much so that I could establish a synthetic long position at a significant discount to the stock price, even if I just ate the cost of the bid/ask spread on both legs.
By the time I figured this out it was after the close, and at any rate I wasnt confident of what I was seeing. Anyway I was happy with the position I had established and decided to just do some research and determine whether what I was seeing was real or a dangerous mirage.
I found a helpful article:
http://www.optionetics.com/market/articles/23780
containing this excerpt:
---------------------------------
In this day and age the expression âThereâs no free lunch on Wall Streetâ is more omnipresent than ever. With the sophistication of the market as it is, youâre unlikely to see this sort of arbitrage gem without a prevalent fishy aroma in the air.
When would you come across this type of âlook, but donât touchâ situation? This kind of pricing is most evident when a trader has inadvertently come across an underlying market which is hard-to-borrow [HTB] for shorting shares or maybe just a very thinly and loosely traded product. Either way, itâs best to be highly skeptical first before you consider placing your order.
In a situation where shares are âHTBâ or impossible to short; calls can trade at a theoretical discount to puts. The reason is the natural hedge to reduce delta or directional risk with short stock is either very tricky business or altogether, not a viable option, pardon the pun. This means the yummy looking value meal isnât the same opportunity offered as part of a regular conversion / reversal market.
--------------
So that makes sense to me, and had occurred to me already: that if the stock is very hard to short, then I cant easily establish a true arbitrage trade by selling the stock and buying calls. But it still seems bizarre and surprising to me that I seem to be able to exploit the put pricing to take on a simulated long position at a very significant discount to the current stock price (significant enough to vastly outweigh commission costs).
Ive looked at other option chains and its a little hard to evaluate them because the market is closed so Im not sure Im seeing option prices that are actually parallel to the stock price, but it looks like there are some disparities around - not quite as big as what I found but big enough that if you wanted to buy the stock anyway (or wanted to liquidate a short position) you would be much better off going the synthetic route.
What am I missing? What should I be wary of?
Thanks for any insight or warnings you can provide...
