Box arbitrage on Sears options

Discussion in 'Options' started by optionsgirl, Apr 20, 2009.

  1. There is quite a difference between the put and call prices for Sears options. Look at the 55 and 60 strikes for May. Unless I am missing something that is a free 0.50 for those quick enough.

    I'm not sure how much it would cost to borrow stock for shorting, but if I were to buy a straddle for Sears, it might be cheaper to short the stock and buy 2 ATM calls.

    I am sure lots of arbitrageurs have nifty software to scan for arbitrage situations all day. I wished I had these tools. I'm not sure how this one slipped through the cracks...
     
  2. dmo

    dmo

    Ah yes, Sears. Before you jump in, let me tell you about my Sears "free money" misadventure, which was most instructional.

    A few months ago I came across an amazing mispricing in Sears - or so it seemed. I could do the reverse conversion (reversal) for quite a bit of free money. The stock was available to borrow, and there were no dividends coming up.

    Unable to find the catch, I did a few - mostly to see what would go wrong. At first it seemed as though it was good. I was making about 20% on the dollar value of the shorted stock.

    However, when I poked deep into the electronic bowels of my IB statement, I learned they were charging me 35% interest on the borrowed stock! Very sneaky of them - they should somehow have made it clear there was an extraordinary borrowing cost for this stock. But they didn't.

    So don't feel bad about missing out on free money - I'm sure you're not.
     
  3. Ouch. 35 percent? So why not just do a Box arbitrage instead of a reversal with short stock?
     
  4. There are no free lunches.

    And DMO should get royalties from ET for sharing his Sears adventure over and over with those seeking a free lunch :)
     
  5. Try the search function.

    A box is simply a call and put vertical. The SHLD long box is a discounted synthetic long at x, which is offset by the discounted short synthetic at y. Put simply, your gains at x are countered by the loss at y. The true value of the natural short is derived via pricing the synthetic short using a same-strike put and call. You can solve for the return on the box using this method.

    All puts are expensive and all calls are cheap. Calculate the implied forward.
     
  6. You are most likely right about free lunches. I just redid the math and the "free" money ranges from .05 to .07. The spread and commissions will kill that easily. It's funny. I didn't realize dmo has shared his sears story many times. Luckily I was skeptical and felt it was too good to be true to do anything.

    However, have anyone found a profitable arbitrage situation for a regular conversion? You know, a situation where calls are much more expensive than puts?
     
  7. Sure, 100s of times.
     
  8. Skeptical is the right approach. Most of the time, if it looks too good to be true it is.

    While it proves nothing, I used to look for conversions and reversals. I found some but I could never get size nor was the return worth the time spent looking. My conclusion was that it was just something that I had to leg into in order to get anywhere.
     
  9. nravo

    nravo

    IB charges 35% to short stock? Is this new? A special case? Never happened to me but I have never shorted Sears, unfortunately.
     
  10. dmo

    dmo

    I'm not saying this is their general everyday policy with all stocks. But if a stock becomes hard to borrow, they'll charge what the market will bear. And unless you know exactly where to look, you will be none the wiser. It's very well hidden. There is nothing on the account information you normally look at that will give you a clue. A few of us here got blindsided by this.

    This post tells you where to look http://www.elitetrader.com/vb/showthread.php?s=&postid=2057096#post2057096
     
    #10     Apr 22, 2009