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
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, 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
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 mensu ...
a
put, and
* long the
underlying
The call and put have the same
strike
Strike may refer to:
People
* Strike (surname)
Physical confrontation or removal
*Strike (attack), attack with an inanimate object or a part of the human body intended to cause harm
*Airstrike, military strike by air forces on either a suspected ...
value and
expiration 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
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 mensu ...
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.
The call and put have the same
strike
Strike may refer to:
People
* Strike (surname)
Physical confrontation or removal
*Strike (attack), attack with an inanimate object or a part of the human body intended to cause harm
*Airstrike, military strike by air forces on either a suspected ...
value and
expiration 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 Busin ...
*
Options strategies
*
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
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)