You buy the straddle for 4.15 You buy the 65 call, sell the 65 put for a forward price of 54.95. you sell the 55 call 2x at 2.15 for a forward price of 55.15 with the straddle. that’s an arb of 20 cents I think.
I knew I saw this example previously, and here it is: https://moontowermeta.com/mock-trading-options-with-market-makers/
I think that's most of the puzzle pieces together here, so let's dissect the position: 1. We buy the 55 straddles for 4.15 2. We sell the 55 calls for 2.15 -> long 200 55 puts 3. We buy 400 65 calls for 0.05$ 4. We sell 200 65 puts at 20.10 - > long 200 55/65 straddles at 2.05$ AND we're long 20.000 shares synthetically 5. We sell 400 calls at 1.05$ Final position: 200 55/60/65 butterflies Price: 55 strike: buy straddle at 4.15, sell calls at 2.15. Long 55 puts at 2.00. 65 strike: the combo price is 65 -10.10+0.05 = long 20.000 shares at 54.95$ + long 200 calls at 0.05 -> Long 55 puts at 2.00 + long stock at 54.95: Long calls at 54.95-55+2.00= 1.95 60 strike: well...1.05$^^ So the fly goes for 1.95-2x1.05+0.05= -0.10 meaning we get paid to leg into a butterfly We can derive vol from the straddle by using the short cut 0.8*Stock*sigma*sqrt(time to expiry in years): 4.20 (asuming taking offers)=0.8*55(derived from the combo)*sigma*sqrt(0.25). Solved for sigma equals 19% If you put that number into a n option pricer you get a theo price for the fly of 0.93$ and we got paid 10 cts for it. Our edge is 1.03$
while he created a massively expected value positive trade, it’s not an arbitrage as he can lose money. If he didn’t delta hedge it, it would have been an arb.
Heyyyy you found it! Many thanks, man, I haven't bookmarked that blog and was actually looking for it.
You're right. The arb is for 10cts. The remaining 93cts is asuming that you've sold the fly right away at theo or better.
Thanks for participating, guys. And of course, there is a prize: https://akunacapital.teachable.com/courses/ An options basics course from market maker Akuna Capital. It's completly free and if you solve all the quizzes, you might even get a hire offer from them Good luck
A bit of an anti-climax in the end - I was hoping the answer would be something that's actionable, but in the heat of the battle, with prices changing all the time, for a Joe Bloggs retail trader, to be able to calculate the following 6 trades : 1. Buy 200 55 straddles for $4.15 2. Sell 200 55 calls at $2.15 3. Sell 400 60 calls at $1.05 4. Buy 400 65 calls for $.05 5. Sell 200 65 puts at $10.10 6. Sell 3,000 shares of stock for $54.95 .....just to figure out if there is an edge or not, and how much it is and to use it, is a little impractical.
It took me about 5 minutes staring at my iPhone while working on a puzzle with my 4yo. However a pit trader would see an opportunity in a few seconds. It’s what they train themselves to do: to observe the price and sense where the bid/ask has a kink (defined by a skewed mid price).