Derivatives arbitrage opportunities in India

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Imagine a situation where you would be required to simultaneously establish a long and short position on Nifty Futures, expiring in the same series. How would you do this and more importantly why would you do this? We will address both these questions in this chapter. To begin with let us understand how this can be done and later move ahead to understand why one would want to do this if you are curious, arbitrage is the obvious answer.

Options as you may have realized by now, are highly versatile derivative instruments; you can use these instruments to create any kind of payoff structure including that of the futures both long and short futures payoff. In this chapter we will understand how we can artificially replicate a long futures pay off using options.

As trading for stock options and futures arbitrage can see, the long futures position has been initiated atand at that point you neither make money nor lose money, hence the point at which you initiate the position becomes the breakeven point.

You make a profit as the futures move higher than the breakeven point and you make a loss the lower the futures move below the breakeven point. Because of this linearity in payoff, the future is also called a linear instrument. Let us take an example to understand this better. Assume Nifty is atwhich would make the ATM strike.

Synthetic Long would require us to go long on CE, the premium for this is Rs. The net cash outflow would be the difference between the two premiums i. Atthe CE would expire worthless, hence we would lose the premium paid i.

However trading for stock options and futures arbitrage PE would have an intrinsic value, which can be calculated as follows —.

Clearly, since we are short on this option, we would lose money from the premium we have received. The loss would be —. Do note, 27 also happens to be the net cash outflow of the strategy, which is also the difference between the two premiums.

With the above 4 scenarios, we can conclude that the strategy makes money while the market moves higher and loses money while the market goes lower, similar to futures. However this still does not necessarily mean that the payoff is similar to that of futures. If the payoff is identical, then clearly there is linearity in the payoff, similar to futures.

The payoff around this point should be symmetric. Clearly, there is payoff symmetry around the breakeven, and for this reason, the Synthetic Long mimics the payoff of the long futures instrument.

And when you plot the Net Payoff, we get the payoff structure which is similar to the long call futures. Having figured out how to set up a Synthetic long, we need to figure out the typical circumstances under which setting up a synthetic long trading for stock options and futures arbitrage required.

If executed well, arbitrage trades binary broker test questions and answers almost risk free.

Let me attempt to give you a simple example of an arbitrage opportunity. The neighboring city which is kms trading for stock options and futures arbitrage has a huge demand for the same fresh sea fish. However, in this neighboring city the same fish is sold at Rs. Given this if you can manage to buy the fish from your city at Rs. Maybe you will have to account for transportation and other logistics, and instead of Rs. This is still a beautiful deal and this is a typical arbitrage in the fish market!

It looks perfect, think about it — if you can do this everyday i. This is indeed risk free, provides nothing changes. But if things change, so will your profitability, let me list few things that could change —.

I hope the above discussion gave you a quick overview on arbitrage. In fact we can define any arbitrage opportunity in terms of a simple mathematical expression, for example with respect to the fish example, here is the mathematical trading for stock options and futures arbitrage —. If there is an imbalance in the above equation, then we essentially have an arbitrage opportunity. In all types of markets — fish market, agri market, currency market, and stock market such arbitrage opportunities exist and they are all governed by simple arithmetic equations.

Arbitrage opportunities exist in almost every market, one needs to be a keen observer of the market to spot it and profit from it. Typically stock market based arbitrage opportunities allow you to lock in a certain profit small but guaranteed and carry this profit irrespective of which direction the market moves. For this reason arbitrage trades are quite a favorite with risk intolerant traders.

I will skip discussing the Put Call Parity theory but would instead jump to illustrate one of its applications. Do note, all the trading for stock options and futures arbitrage belong to the January series. Going by the arbitrage equation stated above, if one were to execute the trade, the positions would be —.

Do note, the first two positions together form a long synthetic long. You could test this across any expiry value in other words the markets can move in any direction but you are likely to pocket One has to account for the cost of execution of this trade and figure out if it still makes sense to take up the trade. So considering these costs, the efforts to carry an arbitrage trade for 10 points may not make sense. But it certainly would, if the payoff was something better, maybe like 15 or 20 points.

With 15 or 20 points you can even maneuver the STT trap by squaring off the positions just before expiry — although it will shave off a few points. Sir it look very nice stratergy. Mahesh, you spot it. There is nothing like an ideal condition for this strategy. It will be trading for stock options and futures arbitrage 69 Rs.

In scenario one you are calculating as loss. In scenario 2 you are calculating 27 as loss. In scenario 4 you are calculating as profit whereas in case of future the trading for stock options and futures arbitrage would be I would like to take trading for stock options and futures arbitrage of the same and revert back if I am mistaken. Why do you think the CE would not be and why 69 specifically? I would suggest you download the excel and work around with the numbers to get more clarity. Wherever any mismatch is there the arbitration opportunity arises and immediately encashed by some trader.

Hi kartik If nifty call option has premium rs. Margins for writing options is usually same as that of the margins required for futures. The premium value is not really considered. Well, a lot of professional traders like to take up trades where there is complete visibility on the downside risk trading for stock options and futures arbitrage though the reward is limited.

Rohan, the module is work in progress. I suppose another 8 chapters to go. Once this is done we will have the PDFs ready. Hi kartik Very very thank to you for clearing my doubts about option selling.

Clearly it make sense to buy option when premium is less and to write option when premium is high. I mean fluctuations happen in milliseconds. There are few opportunities that exist for few over few seconds. I guess its best if you can run a program to keep track of this. Sir, isnt calender spread a sort of arbitrage then. Hi kartik Since margin required for option selling is same as that of futures and not on premium.

So, selecting which strike price yields maximum profit for option seller, whether it is deep otm, otm, ATM, itm or deep itm?????? The further you move away from ATM, the higher is your safety and lower is the profits. It is upto you to identify a sweet spot and write that option. The margin for selling options differs from strike yo strike. Sir, What is the advantage of only synthetic long? Just long call is having unlimited profit and limited loss. Secondly, to maximise the profit the difference between strike price and future price shall be more and difference in the premium of the CE AND PE shall be minimum.

On its own the Synthetic Long is just like futures. But you can use this to identify and structure an arbitrage trade as explained in the chapter. Hi kartik Appropriately, almost for all nifty options the premium was roughly rs.

So trading for stock options and futures arbitrage a trend please suggest me whether it is wiseful to write a deep itm option and collecting big premium in single trade or Selling atm option for every fall then exiting position and writing next ATM option and then exiting and so on doing when the trade lasts Or whether premium declines more fast in otm or deep otm.

See unfortunately there is no 1 strategy that suits all, everyone has different risk reward perspective and hence what works for me will never work for you or vice versa. Taking real market example. No profit or loss can happen. But what will happen on expiry day? As feb expiry has to happen with the spot rate which is way higher than feb future? What strategy Can I use to shift on expiry day and pocket the difference between trading for stock options and futures arbitrage two futures.?

On the day of expiry in Feb, the spot and Feb futures will converge to a single point, this does not guarantee the convergence of March futures, so this is a bit tricky. Is there any automated software trading for stock options and futures arbitrage can let me know the arbitrage opportunity live.

Because EOD prices may or may not be relevant on the following day. If available what will be the approximate cost. Or any info about who sells such software. Using Excel and nseindia will not trading for stock options and futures arbitrage of much use because the prices are too delayed.

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Imagine a situation where you would be required to simultaneously establish a long and short position on Nifty Futures, expiring in the same series. How would you do this and more importantly why would you do this? We will address both these questions in this chapter. To begin with let us understand how this can be done and later move ahead to understand why one would want to do this if you are curious, arbitrage is the obvious answer.

Options as you may have realized by now, are highly versatile derivative instruments; you can use these instruments to create any kind of payoff structure including that of the futures both long and short futures payoff. In this chapter we will understand how we can artificially replicate a long futures pay off using options. As you can see, the long futures position has been initiated at , and at that point you neither make money nor lose money, hence the point at which you initiate the position becomes the breakeven point.

You make a profit as the futures move higher than the breakeven point and you make a loss the lower the futures move below the breakeven point. Because of this linearity in payoff, the future is also called a linear instrument. Let us take an example to understand this better.

Assume Nifty is at , which would make the ATM strike. Synthetic Long would require us to go long on CE, the premium for this is Rs.

The net cash outflow would be the difference between the two premiums i. At , the CE would expire worthless, hence we would lose the premium paid i.

However the PE would have an intrinsic value, which can be calculated as follows —. Clearly, since we are short on this option, we would lose money from the premium we have received. The loss would be —. Do note, 27 also happens to be the net cash outflow of the strategy, which is also the difference between the two premiums.

With the above 4 scenarios, we can conclude that the strategy makes money while the market moves higher and loses money while the market goes lower, similar to futures. However this still does not necessarily mean that the payoff is similar to that of futures. If the payoff is identical, then clearly there is linearity in the payoff, similar to futures.

The payoff around this point should be symmetric. Clearly, there is payoff symmetry around the breakeven, and for this reason, the Synthetic Long mimics the payoff of the long futures instrument.

And when you plot the Net Payoff, we get the payoff structure which is similar to the long call futures. Having figured out how to set up a Synthetic long, we need to figure out the typical circumstances under which setting up a synthetic long is required. If executed well, arbitrage trades are almost risk free. Let me attempt to give you a simple example of an arbitrage opportunity. The neighboring city which is kms away has a huge demand for the same fresh sea fish.

However, in this neighboring city the same fish is sold at Rs. Given this if you can manage to buy the fish from your city at Rs.

Maybe you will have to account for transportation and other logistics, and instead of Rs. This is still a beautiful deal and this is a typical arbitrage in the fish market! It looks perfect, think about it — if you can do this everyday i. This is indeed risk free, provides nothing changes. But if things change, so will your profitability, let me list few things that could change —. I hope the above discussion gave you a quick overview on arbitrage. In fact we can define any arbitrage opportunity in terms of a simple mathematical expression, for example with respect to the fish example, here is the mathematical equation —.

If there is an imbalance in the above equation, then we essentially have an arbitrage opportunity. In all types of markets — fish market, agri market, currency market, and stock market such arbitrage opportunities exist and they are all governed by simple arithmetic equations. Arbitrage opportunities exist in almost every market, one needs to be a keen observer of the market to spot it and profit from it.

Typically stock market based arbitrage opportunities allow you to lock in a certain profit small but guaranteed and carry this profit irrespective of which direction the market moves. For this reason arbitrage trades are quite a favorite with risk intolerant traders. I will skip discussing the Put Call Parity theory but would instead jump to illustrate one of its applications. Do note, all the contracts belong to the January series.

Going by the arbitrage equation stated above, if one were to execute the trade, the positions would be —. Do note, the first two positions together form a long synthetic long. You could test this across any expiry value in other words the markets can move in any direction but you are likely to pocket One has to account for the cost of execution of this trade and figure out if it still makes sense to take up the trade.

So considering these costs, the efforts to carry an arbitrage trade for 10 points may not make sense. But it certainly would, if the payoff was something better, maybe like 15 or 20 points. With 15 or 20 points you can even maneuver the STT trap by squaring off the positions just before expiry — although it will shave off a few points.

Sir it look very nice stratergy. Mahesh, you spot it.. There is nothing like an ideal condition for this strategy. It will be practically 69 Rs. In scenario one you are calculating as loss.

In scenario 2 you are calculating 27 as loss. In scenario 4 you are calculating as profit whereas in case of future the profit would be I would like to take note of the same and revert back if I am mistaken.

Why do you think the CE would not be and why 69 specifically? I would suggest you download the excel and work around with the numbers to get more clarity. Wherever any mismatch is there the arbitration opportunity arises and immediately encashed by some trader. Hi kartik If nifty call option has premium rs.

Margins for writing options is usually same as that of the margins required for futures. The premium value is not really considered. Well, a lot of professional traders like to take up trades where there is complete visibility on the downside risk even though the reward is limited. Rohan, the module is work in progress. I suppose another 8 chapters to go. Once this is done we will have the PDFs ready. Hi kartik Very very thank to you for clearing my doubts about option selling.

Clearly it make sense to buy option when premium is less and to write option when premium is high. I mean fluctuations happen in milliseconds. There are few opportunities that exist for few over few seconds.

I guess its best if you can run a program to keep track of this. Sir, isnt calender spread a sort of arbitrage then.. Hi kartik Since margin required for option selling is same as that of futures and not on premium. So, selecting which strike price yields maximum profit for option seller, whether it is deep otm, otm, ATM, itm or deep itm?????? The further you move away from ATM, the higher is your safety and lower is the profits. It is upto you to identify a sweet spot and write that option.

The margin for selling options differs from strike yo strike. Sir, What is the advantage of only synthetic long? Just long call is having unlimited profit and limited loss. Secondly, to maximise the profit the difference between strike price and future price shall be more and difference in the premium of the CE AND PE shall be minimum. On its own the Synthetic Long is just like futures. But you can use this to identify and structure an arbitrage trade as explained in the chapter. Hi kartik Appropriately, almost for all nifty options the premium was roughly rs.

So in a trend please suggest me whether it is wiseful to write a deep itm option and collecting big premium in single trade or Selling atm option for every fall then exiting position and writing next ATM option and then exiting and so on doing when the trade lasts Or whether premium declines more fast in otm or deep otm. See unfortunately there is no 1 strategy that suits all, everyone has different risk reward perspective and hence what works for me will never work for you or vice versa.

Taking real market example. No profit or loss can happen.. But what will happen on expiry day? As feb expiry has to happen with the spot rate which is way higher than feb future? What strategy Can I use to shift on expiry day and pocket the difference between these two futures..? On the day of expiry in Feb, the spot and Feb futures will converge to a single point, this does not guarantee the convergence of March futures, so this is a bit tricky.

Is there any automated software that can let me know the arbitrage opportunity live. Because EOD prices may or may not be relevant on the following day. If available what will be the approximate cost.

Or any info about who sells such software. Using Excel and nseindia will not be of much use because the prices are too delayed.