Options arbitrage is a trading strategy using
arbitrage
In economics and finance, arbitrage (, ) is the practice of taking advantage of a difference in prices in two or more markets; striking a combination of matching deals to capitalise on the difference, the profit being the difference between t ...
in the
option
Option or Options may refer to:
Computing
*Option key, a key on Apple computer keyboards
*Option type, a polymorphic data type in programming languages
*Command-line option, an optional parameter to a command
*OPTIONS, an HTTP request method
...
s 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, a type of betting in poker
* Call, in the game of contract bridge, a bid, pass, double, or redouble in the bidding stage
Music and dance
* Call (band), from Lahore, Pak ...
,
*
long a
put, and
* long the
underlying
In finance, a derivative is a contract that ''derives'' its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the "underlying". Derivatives can be us ...
The call and put have the same
strike 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.
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.
Not all countries impose a c ...
purposes, while locking in the current price.
Reversal
A ''reversal'' (or reverse conversion) position is:
*
long a
call
Call or Calls may refer to:
Arts, entertainment, and media Games
* Call, a type of betting in poker
* Call, in the game of contract bridge, a bid, pass, double, or redouble in the bidding stage
Music and dance
* Call (band), from Lahore, Pak ...
,
*
short a
put, and
* short the
underlying
In finance, a derivative is a contract that ''derives'' its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the "underlying". Derivatives can be us ...
.
The call and put have the same
strike 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.
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 Busi ...
*
Options strategies
*
Synthetic options position
*
Volatility arbitrage
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)