Feedback on this options arb trade

Discussion in 'Options' started by lescor, May 11, 2005.

  1. lescor


    That GM reversal trade and ensuing discussion got the brain juices flowing and I've been watching for a few different setups to see if the whole options arb strategy is worth pursuing for me.

    I put on a box in MO today and I think I got it right, but would like some feedback in case I'm missing something.

    short a june 60 call at 6.10
    long a june 60 put at .75
    long a june 70 call at .75
    short a june 70 put at 5.70

    This position will be worth $10 at expiry in 5 weeks and I'm short it at 10.30. I did 10 lots on all the legs, so I take in $10,300 which I will collect interest on (positive cost of carry).

    Aside from pin risk and the possibility of early exercise, is this not a riskless trade?
  2. Might be a relatively riskless trade so I gotta read up on boxes. but on this 10 lot you'll be making $42 on interest at 4% for 37 days PLUS the 300 juice you will be taking out. That is $342. Then factor in the commission of 40 lots in and 40 lots out at $1 (lets say) your pnl of 342 gets lesened by 80. And that is not counting the slippage of legging out of the 4 way ( although slippage works both ways I guess..)
  3. Trajan


    It took me a second to realize that this is MO and not GM. I was about to say that those 70 puts were going to be exercised early. When's the dividend? That could throw this off a little.
  4. Choad


    Interesting trade, lescor. Did you leg into this box, or did you put it on with one order? If it was a leg-in, then I can see how you are doing it. Otherwise, it's hard to believe all the option sharks in the market are letting these morsels get away from them.

    Looks like your advantage is coming from the skew on the 70's. The short 70 put has much higher IV than the long 70 call.

    But anyway, good luck with your trade.
  5. interest rate risk...I believe but out the door, so will reassess.
  6. lescor


    I entered by sitting on the offer of the higher priced contracts while watching the bids or offers I would have to hit on the other three and still get in at the price I wanted. When my offer on the 70 put was filled, I just hit the bid on the 60 call and paid the offer on the others. I wasn't relying on a move in the common to help prices come to me.

    MO pays a .73 dividend prior to June expiration, but I don't understand how this could impact things.

    Interest rate risk makes sense, although the prospect of rates moving enough in the next month to have more than a miniscule affect seems rather low.

    The main thing I'm trying to learn is if a strategy like this whereby a trader can amass many positions that carry very very low risk and pay modest amounts, especially if they have a positive carry, is viable. If so then it is an excellent way to use professional leverage. In a prop account you can have almost unlimited buying power and if you can avoid the haircut charges, which you usually can with convertible or 100% hedged positions like this, then you can take those modest gains and really make something out of them. Anybody here trade this way?

    Thanks for the input so far.
  7. MO should declare a dividend later this month. If it follows past history, it will go ex for $.73 just before the June expiration. The probability of the June 60 calls being exercised and having to pay the dividend may be worth considering.
  8. Trajan


    I hope I'm wrong on this, but I think you just legged into a possible loss. Those 60 calls will get exercised with the stock right here. The cash flow looks like this:

    1. sold the box for 10.30
    2. 60 calls get exercised, sell stock at 60
    3. pay .73 dividend since short stock
    4. the 70p get exercised at expiration buy stock at 70
    5. pay a net debit of 10.73, does not include interest paid

    I hope I'm doing something wrong here. Somebody double check this.
  9. Choad


    Oops. I forgot about that chunky quarterly div.

    But hell, even if the trade doesn't work at least we all learned something!

    Good trading to all.

  10. I think Trajan is correct. Modeled it on Hoadley.

    You make $ only if MO is <59.50 .

    Early exercise and dividends are a common gotcha.

    This aint the old days. EVERYTHING is modeled on computers. Unless the programmers screw up, there will be no mistake . The recent GM arb was unusual and involved risk that was invisible to most.

    Look at the KMG arb. I am presuming that there is considerable call in risk on a short stock position as we come to the tender cutoff. If not , then large coin is being offered for the taking. Maybe you can make back this bungle Lescor.
    #10     May 11, 2005