1. Arbitrage is taking advantage of price differences between markets to make riskless profits.
2. For example, an arbitrageur could buy a stock trading at $10 on one exchange and immediately sell it at $10.20 on another, pocketing the $0.20 difference.
3. The document describes examples of arbitrage strategies using stocks, futures, and options to exploit temporary discrepancies in prices.
1. • Let's say you own 100 shares of XYZ stock, which is currently
trading at $50 per share. You are worried that the stock price
might fall in the future, but you don't want to sell your shares
and miss out on potential gains if the stock price rises.
• Hedge your position using option
• If the stock price falls below the strike price of $45
• On the other hand, if the stock price stays above the strike price
of $45 – i.e 55
• Call/Put option premium of $2 per share at the strike price of 45
2. • Suppose you buy one XYZ put option with a strike price of $45 and an
expiration date of one month from now. You pay a premium of $2 per
share, which means you spend a total of $200 (since each option
contract represents 100 shares of the underlying stock).
• If the stock price falls below the strike price of $45, the put option will
be "in the money" and you can exercise your right to sell the stock at
that price. This means you can limit your losses to $5+$2 per share,
even if the stock price drops further.
• On the other hand, if the stock price stays above the strike price of
$45, the put option will expire worthless, but you still own the
underlying stock. In this case, you have only lost the premium you paid
for the option.
3. • Let's say you have sold short 100 shares of XYZ stock futures,
which is currently trading at $50 per share. You expect the stock
price to fall, but you are worried that it might rise instead, leading to
potential losses.
• option with a strike price of $55 @ premium of $2 per share
• Hedge the position
• If the stock price rises above the strike price of $55- 60,65,70
• If the stock price falls bellow the strike price of $55- 50,45,40
4. • Suppose you buy one XYZ call option with a strike price of $55
and an expiration date of one month from now. You pay a
premium of $2 per share, which means you spend a total of
$200 (since each option contract represents 100 shares of the
underlying stock).
• If the stock price rises above the strike price of $55, the call
option will be "in the money" and you can exercise your right to
buy the stock at that price. This means you can limit your losses
to $55 per share, even if the stock price continues to rise.
5. • Arbitrage is a trading strategy that involves taking advantage of
price discrepancies between two or more markets to make a
profit. One common way to engage in arbitrage with stock
futures is by using a cash and carry arbitrage strategy. Here's
an example:
6. • Suppose that the current spot price of XYZ stock is $50, and the
futures contract for XYZ stock with a delivery date of one month
from now is trading at $55. This suggests that the market
expects the stock price to rise in the future.
• You have $50,000 in cash and you want to engage in arbitrage
with stock futures.
• The spot price of XYZ stock remains at $50 per share
• The spot price of XYZ stock rises to $55 per share
• The spot price of XYZ stock falls to $45 per share,
7. • You have $50,000 in cash and you want to engage in arbitrage
with stock futures. You decide to use a cash and carry arbitrage
strategy, which involves buying the underlying asset (in this
case, the XYZ stock) in the spot market and simultaneously
selling a futures contract on the same underlying asset.
8. • To engage in cash and carry arbitrage, you would do the
following:
1.Buy 1000 shares of XYZ stock at the spot price of $50 per
share, spending $50,000 in cash.
2.Sell one futures contract on XYZ stock with a delivery date of
one month from now at the futures price of $55 per share,
receiving $55,000 in cash
9. At the delivery date, one of three scenarios can
occur:
1.The spot price of XYZ stock remains at $50 per share, and the futures
contract expires worthless. In this case, you have made a profit of
$5,000 ($55,000 received from the futures contract sale minus $50,000
spent on buying the stock in the spot market).
2.The spot price of XYZ stock rises to $55 per share, and the futures
contract settles at the same price. In this case, you have made a profit
of $5,000 ($55,000 received from the futures contract sale minus
$50,000 spent on buying the stock in the spot market).
3.The spot price of XYZ stock falls to $45 per share, and the futures
contract settles at the same price. In this case, you have made a loss of
$5,000 ($50,000 spent on buying the stock in the spot market minus
$45,000 received from the futures contract sale).
10. Arbitrage
Arbitrage is the practice of taking advantage of differences in price or
value between two or more markets, with the goal of making a profit. In
finance, this often involves buying an asset in one market where it is
undervalued and simultaneously selling it in another market where it is
overvalued, thus profiting from the price difference.
For example, suppose that a stock is trading for $10 on the New York
Stock Exchange (NYSE) and simultaneously trading for $10.20 on the
Tokyo Stock Exchange (TSE). An arbitrageur might buy the stock on the
NYSE and sell it on the TSE, earning a profit of $0.20 per share.
Arbitrage opportunities can arise in various markets, including financial
markets, commodity markets, and currency markets. However, arbitrage
opportunities tend to be short-lived, as market forces tend to quickly
eliminate price differences as traders try to take advantage of them.
11. Short Position
• Suppose that the current spot price of XYZ stock is $50, and the
futures contract for XYZ stock with a delivery date of one month
from now is trading at $45. This suggests that the market
expects the stock price to fall in the future.
• You have $50,000 in cash and you want to engage in arbitrage
with a short position in stock futures.
• The spot price of XYZ stock remains at $50 per share
• The spot price of XYZ stock falls to $45 per share
• The spot price of XYZ stock rises to $55 per share
12. • To engage in reverse cash and carry arbitrage, you would do
the following:
1.Short sell 1000 shares of XYZ stock at the spot price of $50 per
share, receiving $50,000 in cash.
2.Buy one futures contract on XYZ stock with a delivery date of
one month from now at the futures price of $45 per share,
spending $45,000 in cash.
13. 1.The spot price of XYZ stock remains at $50 per share, and the
futures contract expires worthless. In this case, you have made a
profit of $5,000 ($50,000 received from the short sale of the stock in
the spot market minus $45,000 spent on buying the futures contract).
2.The spot price of XYZ stock falls to $45 per share, and the futures
contract settles at the same price. In this case, you have made a
profit of $5,000 ($50,000 received from the short sale of the stock in
the spot market minus $45,000 spent on buying the futures contract).
3.The spot price of XYZ stock rises to $55 per share, and the futures
contract settles at the same price. In this case, you have made a
loss of $5,000 ($45,000 spent on buying the futures contract minus
$50,000 received from the short sale of the stock in the spot market).
14. • Suppose that a call option on XYZ stock with a strike price of
$50 and an expiration date of one month from now is trading at
$6. At the same time, a put option on XYZ stock with the same
strike price and expiration date is trading at $5.50. The current
spot price of XYZ stock is $50.
• You have $5,000 in cash and you want to engage in arbitrage
with stock options.
• The spot price of XYZ stock remains at $50 per share
• The spot price of XYZ stock rises to $55 per share.
• The spot price of XYZ stock falls to $45 per share.
15. • You have $5,000 in cash
• A conversion arbitrage strategy: Buying the stock
• Selling the call option
• and buying the put option.
16. 1.Buy 100 shares of XYZ stock at the spot price of $50 per share,
spending $5,000 in cash.
2.Sell one call option on XYZ stock with a strike price of $50 and
an expiration date of one month from now at the options price of
$6, receiving $600 in cash.
3.Buy one put option on XYZ stock with a strike price of $50 and
an expiration date of one month from now at the options price of
$5.50, spending $550 in cash
17. At the expiration date, one of three scenarios can
occur:
1.The spot price of XYZ stock remains at $50 per share. In this case, the call
option expires worthless, and the put option is exercised, allowing you to sell
the stock at the strike price of $50 per share. Your profit in this scenario is
$50 ($5,000 received from the sale of the stock minus $4,950 spent on
buying the put option).
2.The spot price of XYZ stock rises to $55 per share. In this case, the call
option is exercised, allowing you to sell the stock at the strike price of $50
per share, and you buy back the put option. Your profit in this scenario is $50
($5,000 received from the sale of the stock minus $4,950 spent on buying
the put option).
3.The spot price of XYZ stock falls to $45 per share. In this case, the put
option is exercised, allowing you to sell the stock at the strike price of $50
per share, and you buy back the call option. Your profit in this scenario is $50