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A riskless trade with good return for your consideration

Recs

11

March 17, 2010 – Comments (13) | RELATED TICKERS: LB , T , MO

LTD declared a special dividend of $1 per share the other day.

Shares are currently $24.70

Puts for April at $25 (far enough in the future to encompass the ex dividend date for this special divi) have a bid of $0.90 and an ask of $1

Call for April at $25 have a bid of $0.65 and an ask of $0.70

 The trade is this:

1.  buy the shares

2.  buy the puts

3.  sell the calls

4.  collect the dividend as profit.  

In this case you'd spend $24.70 + $0.95 - $0.67 = $24.98.  Your end value would be $25 + the value of hte dividend, or about 426.  Profit $1 or 4% in about a month.  Thats what you make on a 10 year treasury in a year folks, or what you make in a year of holding a Medtronic long term bond. In you did not split the bid/ask spread you'd have $24.70 + 1 - 0.65 = $25.05, 95 cents profit.  

There is no risk here other than the shares of LTD moving well over $25 and someone calling them away from you.  Its rare for calls to be exected ahead of expiration or at any time when there is any time premium left in the call.  In this case the calls are above the money right now, so in general they should not be executed unless the shares move far higher.

OR

1.  buy the shares

2.  buy the puts

3.  skip the calls

4.  Collect the dividend and whatever gains in share price

In this case you'd buy the shares, buy the puts.  You'd collect the dividend (which pays for the puts) and you rprofit would be the sum of these

A)  whatever value is left in the puts after the ex divi day

B)  the value of the shares when you sell them (so if the shares move up to $30 you'd collect $30)

C)  the dividend

Still no risk, but your primary form of profit here would be the shares moving up, which is of course not certain

 

OR

1.  buy the sahres

2.  sell a lower strike call.  The $22.50 call has a bid of 2.25 and an ask of $2.45.  If you split the difference you'd have $2.35 which would set you up for a situation where you 

A)  buy the share ($24.70), sell the call ($-2.35) for a $22.35 investment

B)  collect the divi  (+$1)

C)  let the shares get called  (+$22.50)

For a total profit of $1.15, or about 5% of the invested capital.

This is not zero risk.  If the shares of LTD fall under $22.50 you could lose money.

 

Just an idea for your consideration.  

 

13 Comments – Post Your Own

#1) On March 17, 2010 at 12:25 PM, anchak (99.84) wrote:

Checklist....The first setup is seemingly riskless - what I don't understand is the arbitrage.

Objective: I want the $1 - or at least as much of it as possible to keep.

Method: I need to hold an instrument which fetches me the $. ie need to hold the underlying in some shape or form - so simple - buy the shares.

Lets say 100 shares : so outlay is $2470 ( @24.7/share)

Known: Shares price will adjust post div date by $1.Stock goes ex-div on April 20th I think.

Risk Neutrality

(a) Cover downside risk: best option is to buy the nearest-strike - in the money.

So $25 is correct strike.   

In this case I'll buy 1 contract to hedge my 100 shares.

So buy 1 April 25 LTD put @.95 ( bid+ask/2). Key point here though is that April Puts expire April 16th.

Net outlay : $95.

The trade currenly stands as following

Inflow : $100 Outflow $95.
uncovered risk: 1 day of trading and -$1 hit in price. 

Other than selling the call ....which is a collect premium - trade - but again it does not cover the April 20th date - where by certainty the price will adjust by $1 ....

I am a little confused....how the return comes out.

Thx

 

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#2) On March 17, 2010 at 12:34 PM, checklist34 (99.69) wrote:

maybe i'm on crack.  I had the ex-div date for the special div as april 5.

it pays april 19th, but you can get out anytime after april 5 and get it.

So the april options would cover you.

here's my source for the ex-divi date

Going long a put and short a call at the same strike price is, net, going short a stock.  

So you're long the share (to collect divi) and short the share (with options, no divi) and this should work.  

EDIT, ALL OPTIONS MENTIONED ABOVE WOULD BE FOR APRIL

 

EDIT 2, SOMETIMES SPECIAL DIVIDENDS RESULT IN OPTIONS ADJUSTING, BUT NOT ALWAYS.  I LOST MY FANNY WHEN THE CBOE CHANGED THE RULES ON A SPECIAL DIVIDEND FROM ACAS.  i asked my broker about this one and they did not report a memo about ltd having any special rulings,... and I made a pile on a special divi from wynn earlier this year w/o having option problems so i think we're good.

I tried this with a small position just for kicks. 

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#3) On March 17, 2010 at 12:44 PM, TalibKweli (33.55) wrote:

Most brokers charge not only commission, but a ~$1 clip per option contract. Wouldn't these transaction fees destroy the spread on this trade?

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#4) On March 17, 2010 at 12:49 PM, TLMDrexel (61.17) wrote:

Hi CList34,

Thanks ... I did my own research and took one of your options ...

Bought 100 for 24.71, sold Apr 22.5 Call for 2.40 ...

All the best,

TLMD.

 

 

 

 

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#5) On March 17, 2010 at 1:16 PM, anchak (99.84) wrote:

I was thinking about the same thing - in the last few minutes - I went out.

If the stock goes ex-div on April 5th - the Puts are going to cover you fine.

And yes in order to cover the $ div - the synthetic short from the options makes sense.

What I don't understand is why would some write - a put for April without covering the cretain ( ie Prob =1 ) event of the stock falling by $1 on April 5th. ( Maybe not the $1 - taking into time decay etc) .

Ok lets revisist

(1) Buy $100 LTD common: $2470
(2) Buy 1 LTD April 25 Put for $95
(3) Sell 1 LTD April 25 call - and collect $67

Say nothing changes between now and April 6th ( there's time decay etc always on options - but having both sides minimizes that) 

April 6th.

(1) Collect $100
(2) Sell 100 common @ $2370

So is the profit essentially the delta between the 2 options?

So if we figure in commissions - what's the spread?

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#6) On March 17, 2010 at 1:30 PM, anchak (99.84) wrote:

I am wondering - if the issue is with mispricing of the Put - then what happens if you do not write the call?

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#7) On March 17, 2010 at 1:33 PM, anchak (99.84) wrote:

OR do you think - that's where the problem lies.....

CBOE  - might artificially debunk that arbitrage - but if they do - then it would apply equally to both sides....

In which case - keeping one side open is a little better. Because then, if they don't the put will have the movement - on April 5th. If they do - then essentially you need to cover your costs on the $5 = $100-$95. Most probably not - but it would be very small

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#8) On March 17, 2010 at 1:37 PM, checklist34 (99.69) wrote:

Talib, I have no idea.  I get charged a % of assets from a brokerage for trades. 

Which, BTW, works out to be 10x worse than using an online place like etrade, so don't think that makes me cool.  It makes me retarded if I don't switch unless they can explain to me what I am getting out of it.

 

Anchank:  if you are ong the puts you have the right to sell the stock for $25 regardless of what price it is on the market.

So you'd collect divi and sell the shares for $25

I wonder if the reason the huge arbitrage exists is because the strike price of the options will be reduced by $1?  I can't find any press release to this effect...

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#9) On March 17, 2010 at 1:41 PM, checklist34 (99.69) wrote:

Drexel, remember that you have risk with that situation...  if the shares fall under $22.50 you'll face losses.  Good luck!

 

Anchak:  I got it directly in the shorts on ACAS once.  ACAS was forced to issue a dividend of $1.07 or so last summer.  At the time the shares were trading around 3 bucks

so I bought a pile of new shares (already had some) and sold $2.50 calls against them...

And the next day the CBOE ruled that the options would have to deliver the dividend.  So basically when the calls I was short settled I would have to deliver the dividend in addition to the shares, which was fantastically annoying and I lost some moeny.

http://caps.fool.com/Blogs/ViewPost.aspx?bpid=213901&t=01003772208491358884 Report this comment
#10) On March 17, 2010 at 2:08 PM, Teacherman1 (57.53) wrote:

That seems like a whole lot of work for the return, unless you like the stock anyway. Of course, I'm not a trader and don't use puts and calls, so maybe for you pros it's an easy do. Good luck with it if Mr. Market suddenly decides to nosedive.

Hope you are having a Green day to celebrate St. "Paddy's".

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#11) On March 17, 2010 at 4:16 PM, anchak (99.84) wrote:

Teacherman...if market nosedives - the Put should cover you. That's why its riskless-arbitrage.

Worst case - is you eat the commissions and expenses

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#12) On March 18, 2010 at 2:16 AM, ggeller2004 (< 20) wrote:

Your long put option contract will be adjusted for the special dividend on the ex-dividend date.  The adjustment will subtract $1 from the strike price of the put. (Or add $1 per share to the cost of the put if you want to look at it that way.) Sadly, your position is not riskless afterall in this case.

To make this specific, if you had bought near the close of trading on Macrh 17, you might have purchased 100 shares of stock at $24.68 and an April 25 Put contract at $1.05.

Your break-even price on the stock will be: $24.68 + $1.05 = $25.73

Your maximum possible loss will be $24.68 + $1.05 - $25.00 = $0.73

Your maximum possible gain will be unlimited, based on the price of the stock.

The analysis after the ex-divided date will yeild the maximum possible loss and maximum possible gain. The difference will be that you already have $1 per share dividend promised to you as the dividend and your put option will only pay $24 per share if you choose to exercise it. After the ex-dividend date:

Your break-even price on the stock will be: $24.68 + $1.05 - $1.00 = $24.73

Your maximum possible loss will be $24.68 + $1.05 - $1.00 - $24.00 = $0.73

 

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#13) On April 01, 2010 at 2:52 AM, checklist34 (99.69) wrote:

the options have been adjusted down $1, the amount of the special divi, to $24.

so your profit (my profit in real life) will likely be $0.04, instead of $1.04, no real arbitrage.  

 let this be a lesson to us all

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