Is this a risk free options trade?

Discussion in 'Options' started by m22au, May 7, 2009.

  1. m22au


    Underlying stock is at 10.11

    The following options all have the same expiry:

    10.00 call (bid) $1.60
    11.00 call (ask) $1.20

    10.00 put (ask) $1.40
    11.00 put (bid) $2.15

    sell an equal number of
    10.00 calls at 1.60
    11.00 puts at 2.15
    and buy an equal number of
    11.00 calls at 1.20
    10.00 puts at 1.40

    Total credit = 1.60 + 2.15 - 1.20 - 1.40 = 1.15 less commissions

    if stock closes below 10.00, then
    keep 1.15 premiums
    max loss on put position is $1.00

    if stock closes above 11.00, then
    keep 1.15 premiums
    max loss on call position is $1.00

    if stock closes between 10.00 and 11.00, then
    keep 1.15 premiums
    total payout to holders of the 10.00 calls and 11.00 puts will always be 1.00

    Have I made any mistakes with the above?
  2. m22au


    Well I just learnt that my strategy is a box spread:

    But I'm still surprised that it is paying $1.15 (less commissions) for a payout at expiry of $1.00,

    unless I have made an error in calculation.
  3. Your bid/ask quotes could be "stale" and do not properly reflect the market.
  4. donnap


    Your initial post was mistaken but it is a box and can be looked at as a symthetic long and short.

    The long is at the 11 strike 11 - .95 credit = 10.05 cost

    The short at 10 + .20credit = 10.20

    So, yes .15 gain at any price.
  5. m22au


    Thanks for your suggestion nazzduck.

    However I am pleased to report that my quotes are not stale, and I executed a small trade at those prices.

  6. m22au


    Thank you Donnap.

    Yes that is a good way of thinking about it.

    I did the same kind of thing when I was looking at the payouts in my Excel spreadsheet.

    ie, I quickly realised that the trade involves being long at X and short at Y.

  7. donnap


    Cool. It's not entirely risk free, however.

    If you let it exercise/assign out - then the gain is yours. But there is pin risk.

    If the underlying should be at or very near the 10 or 11 strike at expiry, then you may not be able to be certain of the position closing itself.

    This has happened to me a surprisingly large number of times. You may want to close a side and trade the stock in this case.
  8. m22au


    Thank you for the advice Donnap.

    I will make sure that I'm ready to close out the position at expiry, even if it means giving up some of the 15 cents of "extra" premium that I collected.

  9. More likely there is early exercise risk where you will have to pay a huge premium to hold the short stock because it is most likely a hard to borrow stock which is why the box appeared to be mispriced, and I am sure its more than you collected on the box.
  10. m22au


    Thank you very much xflat.

    You are 100% correct about that risk, and I'll deal with it if and when I get assigned on the $11 put.

    However given that the put has a large time premium (is that the correct terminology?), it is unlikely that I will be assigned soon.

    It's more likely that I will get assigned if/when the stock falls much further, in which case I can exercise my $10 put.

    #10     May 7, 2009