Options arbitrage is a trading strategy using
arbitrage
Arbitrage (, ) is the practice of taking advantage of a difference in prices in two or more marketsstriking a combination of matching deals to capitalize on the difference, the profit being the difference between the market prices at which th ...
in the
options market to earn small profits with very little or zero risk.
Traders perform conversions when options are relatively overpriced by purchasing stock and selling the equivalent options position. When the options are relatively underpriced, traders will do reverse conversions or reversals. In practice, actionable option arbitrage opportunities have decreased with the advent of automated trading strategies.
Conversion
A ''conversion'' position is:
*
short a
call
Call or Calls may refer to:
Arts, entertainment, and media Games
* Call (poker), a bet matching an opponent's
* Call, in the game of contract bridge, a bid, pass, double, or redouble in the bidding stage
Music and dance
* Call (band), from L ...
,
*
long
Long may refer to:
Measurement
* Long, characteristic of something of great duration
* Long, characteristic of something of great length
* Longitude (abbreviation: long.), a geographic coordinate
* Longa (music), note value in early music mens ...
a
put, and
* long the
underlying
In finance, a derivative is a contract between a buyer and a seller. The derivative can take various forms, depending on the transaction, but every derivative has the following four elements:
# an item (the "underlier") that can or must be bou ...
The call and put have the same
strike
Strike may refer to:
People
*Strike (surname)
* Hobart Huson, author of several drug related books
Physical confrontation or removal
*Strike (attack), attack with an inanimate object or a part of the human body intended to cause harm
* Airstrike, ...
value and
expiration
Expiration or expiration date may refer to:
Expiration
Expiration may refer to:
*Death
*Exhalation of breath, breathing out
* Expiration (options), the legal termination of an option to take an action
*Shelf life, or the time after which a product ...
date. The resulting portfolio is
delta neutral
In finance, delta neutral describes a portfolio of related financial securities, in which the portfolio value remains unchanged when small changes occur in the value of the underlying security (having zero delta). Such a portfolio typically contain ...
.
One reason a trader may take this position would be to extend the holding period of the underlying position for
capital gains tax
A capital gains tax (CGT) is the tax on profits realized on the sale of a non-inventory asset. The most common capital gains are realized from the sale of stocks, bonds, precious metals, real estate, and property.
In South Africa, capital g ...
purposes, while locking in the current price.
Reversal
A ''reversal'' (or reverse conversion) position is:
*
long
Long may refer to:
Measurement
* Long, characteristic of something of great duration
* Long, characteristic of something of great length
* Longitude (abbreviation: long.), a geographic coordinate
* Longa (music), note value in early music mens ...
a
call
Call or Calls may refer to:
Arts, entertainment, and media Games
* Call (poker), a bet matching an opponent's
* Call, in the game of contract bridge, a bid, pass, double, or redouble in the bidding stage
Music and dance
* Call (band), from L ...
,
*
short a
put, and
* short the
underlying
In finance, a derivative is a contract between a buyer and a seller. The derivative can take various forms, depending on the transaction, but every derivative has the following four elements:
# an item (the "underlier") that can or must be bou ...
.
The call and put have the same
strike
Strike may refer to:
People
*Strike (surname)
* Hobart Huson, author of several drug related books
Physical confrontation or removal
*Strike (attack), attack with an inanimate object or a part of the human body intended to cause harm
* Airstrike, ...
value and
expiration
Expiration or expiration date may refer to:
Expiration
Expiration may refer to:
*Death
*Exhalation of breath, breathing out
* Expiration (options), the legal termination of an option to take an action
*Shelf life, or the time after which a product ...
date. The resulting portfolio is
delta neutral
In finance, delta neutral describes a portfolio of related financial securities, in which the portfolio value remains unchanged when small changes occur in the value of the underlying security (having zero delta). Such a portfolio typically contain ...
.
See also
*
Binary option
A binary option is a financial exotic option in which the payoff is either some fixed monetary amount or nothing at all.Breeden, D. T., & Litzenberger, R. H. (1978). "Prices of state-contingent claims implicit in option prices". ''Journal of Busin ...
*
Options strategies
Option strategies are the simultaneous, and often mixed, buying or selling of one or more options that differ in one or more of the options' variables. Call options, simply known as Calls, give the buyer a right to buy a particular stock at that ...
*
Synthetic options position
In finance, a synthetic position is a way to create the payoff of a financial instrument using other financial instruments.
A synthetic position can be created by buying or selling the underlying financial instruments and/or derivatives.
If s ...
*
Volatility arbitrage In finance, volatility arbitrage (or vol arb) is a term for financial arbitrage techniques directly dependent and based on volatility.
A common type of vol arb is type of statistical arbitrage that is implemented by trading a delta neutral po ...
References
Option Arbitrage* {{cite book
, last = McMillan, first = Lawrence G.
, title = Options as a Strategic Investment
, edition = 4th
, publisher = Prentice Hall
, year = 2002
, isbn = 0-7352-0197-8
Arbitrage
Options (finance)
Derivatives (finance)