Risk-free option trade or I am missing something?

[grass_hopper]

Hey guys,

Yesterday I executed the following trade on SPY options, SPY was around 126 at that time:

Bought 200 SPY Dec11 124 PUT (SPYX1711C124000) @ $1.45
Bought 200 SPY Dec11 128 CALL (SPYL1711C128000) @ $1.53
Sold 200 SPY Dec11 128 PUT (SPYX1711C128000) @ $3.17
Sold 200 SPY Dec11 124 CALL (SPYL1711C124000) @ $3.99

Credit per share: $4.18
The total sum of the transaction, less commissions is a credit of $83035.24

Now, the expiration value of the spread is $4/share: $80564.76 with commissions if sold, or $80030 if excersiced/assigned. This leaves a risk-free profit of $2470.48 or $3005 depending on the exit method.

In interim, this combination may decline in value by $900 at most, thus margin requirement is ~$1K.

This looks like an arbitrage trade but I could not find a similar one in the other months. Is this a real situation or there was some glitch in pricing since I did the trade on my demo account at tradeMONSTER?

I checked the prices today and a similar trade can still be created with 123/127 options.

 

[Rhody Trader]

Are your prices above using offer levels for the long trades and bid prices for the shorts? In the real world the spread will most definitely wipe out the profitability of this sort of position.

 

[grass_hopper]

I entered a custom spread order @-4.18 limit. -4.18 was an ask price at the time (-4.17 as of this writing) the bid was -4.23. The order got executed almost immediately.
If you have a live account and you broker allows multi-leg orders, try to enter it and see what happens.

 

[Martinghoul]

I have looked at it and it looks, at first glance, real, which is pretty shocking, I have to say. I'll look more closely tomorrow.

 

[anley]

No chance of finding a risk-free options trade on the SPY, NO CHANCE.

Perhaps on some tiny stock but again no chance on a massive share/index like SPY.

 

[Martinghoul]

No chance of finding a risk-free options trade on the SPY, NO CHANCE.

Perhaps on some tiny stock but again no chance on a massive share/index like SPY.

Actually, that's what I would have said as well... However, to my astonishment, this looks like it's real. I'll update later today.

 

[anley]

Well, I'll be happy to be proved wrong, but if you have found something that's risk-free then well done, but shame on you if you didn't mortgage the house

 

[Martinghoul]

Well, I'll be happy to be proved wrong, but if you have found something that's risk-free then well done, but shame on you if you didn't mortgage the house

I will report as soon as I have conclusive information, one way or another.

 

[grass_hopper]

Meanwhile, let's suppose someone executes this transaction for real. In that case, what happens if an ITM option holder that bought, say, 124 Call decides to exercise before expiration? Would this force to unwind the whole position?

 

[grass_hopper]

Just checked the prices. 123/129 spread has .22-.24 profit/share built in. Is anyone willing to try this with a real account?

 

[Martinghoul]

Right, I have done some properly exhaustive research into this... It's REAL, but..., wait for it,... it's NOT free money. The "extra" 10 ticks or so (once you take commissions into account) is the price of the pin risk that is very specific to the SPY. There's also the divs that happen on the 17th and the SPY options are American and physically-settled. So it's not free money, but it might be good cheap money.

 

[scose-no-doubt]

I still don't understand what you're getting paid for if you're taking both sides.

 

[Martinghoul]

I still don't understand what you're getting paid for if you're taking both sides.

You're getting paid for the uncertainty of ending up with a naked long or short over the weekend, basically... As I said, it's not "free money", in principle, but it is pretty good "cheap money".

 

[scose-no-doubt]

What, if a counter party exercises and you don't/can't? This is too confusing.

 

[grass_hopper]

So, what happens at the expiration? My assumption is that the spread can be closed (bought) on Dec 16 at its intrinsic value. If not, then all (if SPY is between the strikes) or half (if SPY is outside the range) options get exercised/assigned and we end up in cash as all these options cancel each other.

 

[Martinghoul]

What, if a counter party exercises and you don't/can't? This is too confusing.

Well, it's the inefficiency of the communication, OK? Suppose you have this trade on, i.e. you're long the call, short the put (and let's suppose you're short the underlying, for a nice "riskless" package). If the options are physically-settled, the position isn't actually riskless. Reason is that you have to make a decision on whether to exercise your calls by smth like 7PM on Friday (I think). However, you don't know whether you have been assigned on your puts till Monday. And that's pin risk for ya, 'cause you might end up with a naked short position over the whole weekend.

 

[Martinghoul]

So, what happens at the expiration? My assumption is that the spread can be closed (bought) on Dec 16 at its intrinsic value. If not, then all (if SPY is between the strikes) or half (if SPY is outside the range) options get exercised/assigned and we end up in cash as all these options cancel each other.

Nah, you won't be likely be able to cover the spread at intrinsic before expiry, although who knows. And there's a host of uncertainties before you get to expiry which is precisely what you're getting rewarded for. Apart from pin risk, there's also an issue of divs which happen arnd the time of expiry, which further complicates matters.

 

[grass_hopper]

Well, it's the inefficiency of the communication, OK? Suppose you have this trade on, i.e. you're long the call, short the put (and let's suppose you're short the underlying, for a nice "riskless" package). If the options are physically-settled, the position isn't actually riskless. Reason is that you have to make a decision on whether to exercise your calls by smth like 7PM on Friday (I think). However, you don't know whether you have been assigned on your puts till Monday. And that's pin risk for ya, 'cause you might end up with a naked short position over the whole weekend.

Why would you be short the underlying? The whole transaction is a so-called "box spread" where no underlying is involved.
BTW, can you choose to exercise long option only if the short one is assigned? Or force assignment and exercise in a certain order? E.g., exercise long call and then get assigned on the short put to end up in cash?

 

[Martinghoul]

Why would you be short the underlying? The whole transaction is a so-called "box spread" where no underlying is involved.
BTW, can you choose to exercise long option only if the short one is assigned? Or force assignment and exercise in a certain order? E.g., exercise long call and then get assigned on the short put to end up in cash?

The synthetic that I used was just for purposes of illustrating the principle. I know that your trade doesn't have anything to do with an outright position in the underlying, but the same concerns apply. And no, you can't force anything, that's the whole point of pin risk. It's the price you pay for being short an option. And because these are American, physically-settled options with a div payment arnd expiry, you have all these potential timing concerns ('cause you might get early assignment on your DITM options). Now this is all just to explain that there's a risk that is being priced here, not to say that it's being priced fairly or correctly. Personally, I would do this trade and run the risk. But I wouldn't bet the farm, 'cause, in my experience, these cheap lunches sometimes contain poison.

 

[scose-no-doubt]

Reason is that you have to make a decision on whether to exercise your calls by smth like 7PM on Friday (I think). However, you don't know whether you have been assigned on your puts till Monday

ah okay then this is where I lost you. I have no idea what option assignment is lol. Is this unique to American options?