Options Arbitrage refers to strategies that exploit price inefficiencies in options markets to generate risk-free or low-risk profits. These strategies involve taking offsetting positions in options and/or the underlying asset. Below are common types of options arbitrage strategies:
1. Conversion and Reverse Conversion Arbitrage
- Concept: Exploits mispricing between call and put options of the same strike price and expiration.
- Execution:
- Conversion Arbitrage: Buy the underlying, buy a put, and sell a call.
- Reverse Conversion: Short the underlying, sell a put, and buy a call.
- Goal: Lock in a risk-free profit from discrepancies in put-call parity.
2. Calendar Arbitrage
- Concept: Takes advantage of mispricing between options with the same strike price but different expiration dates.
- Execution:
- Buy an option with a longer expiration (cheaper time decay).
- Sell an option with a shorter expiration (faster time decay).
- Goal: Benefit from time decay differentials (Theta).
3. Volatility Arbitrage
- Concept: Profits from differences between implied volatility and actual (realized) volatility.
- Execution:
- Go long (buy options) when implied volatility is low compared to historical or forecasted volatility.
- Go short (sell options) when implied volatility is high.
- Goal: Capture the mispricing between expected and realized price movements.
4. Dispersion Arbitrage
- Concept: Exploits the difference in volatility between an index and its constituent stocks.
- Execution:
- Short index options (lower implied volatility).
- Long options on the individual stocks (higher implied volatility).
- Goal: Profit from the difference in volatility pricing.
5. Box Spread Arbitrage
- Concept: A risk-free arbitrage strategy created by combining a bull call spread with a bear put spread.
- Execution:
- Buy a call and sell a call at a higher strike (bull spread).
- Sell a put and buy a put at the same strike prices (bear spread).
- Goal: Earn the difference between the net premium and the discounted value of the strikes.
6. Statistical Arbitrage
- Concept: Uses quantitative models to find short-term mispricings in options markets.
- Execution:
- Combine options and the underlying asset based on historical price relationships.
- Utilize algorithms to manage trades dynamically.
- Goal: Achieve consistent, low-risk returns by exploiting statistical patterns.
Key Considerations
- Transaction Costs: High costs can erode arbitrage profits.
- Liquidity: Illiquid options may hinder execution.
- Execution Risk: Rapid price changes can disrupt arbitrage setups.
- Model Risk: Incorrect assumptions can lead to losses in volatility or statistical arbitrage.