This document discusses different types of arbitrage opportunities in derivatives markets. It describes deterministic arbitrage as strategies that offer risk-less profits, such as cash and carry arbitrage or reverse cash and carry arbitrage. Statistical arbitrage aims to profit from pricing inefficiencies identified by mathematical models and has some risk. Pair trading and exploiting corporate actions are provided as examples of statistical arbitrage strategies. The document also cautions that the views expressed are those of the author and not the financial institution.
This document discusses different types of arbitrage opportunities in derivatives markets. It describes deterministic arbitrage as strategies that offer risk-less profits, such as cash and carry arbitrage or reverse cash and carry arbitrage. Statistical arbitrage aims to profit from pricing inefficiencies identified by mathematical models and has some risk. Pair trading and exploiting corporate actions are provided as examples of statistical arbitrage strategies. The document also cautions that the views expressed are those of the author and not the financial institution.
This document discusses different types of arbitrage opportunities in derivatives markets. It describes deterministic arbitrage as strategies that offer risk-less profits, such as cash and carry arbitrage or reverse cash and carry arbitrage. Statistical arbitrage aims to profit from pricing inefficiencies identified by mathematical models and has some risk. Pair trading and exploiting corporate actions are provided as examples of statistical arbitrage strategies. The document also cautions that the views expressed are those of the author and not the financial institution.
This document discusses different types of arbitrage opportunities in derivatives markets. It describes deterministic arbitrage as strategies that offer risk-less profits, such as cash and carry arbitrage or reverse cash and carry arbitrage. Statistical arbitrage aims to profit from pricing inefficiencies identified by mathematical models and has some risk. Pair trading and exploiting corporate actions are provided as examples of statistical arbitrage strategies. The document also cautions that the views expressed are those of the author and not the financial institution.
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Derivative Classroom
Arbitrage- Series VIII
November 18, 2009
Derivative Classroom -Series V ` Arbitrage
An arbitrage is the practice of capitalizing on mis-pricing existing between two
markets. It is a combination of deals that takes advantage of the imbalance prevailing in cash and future market. In the field of investing, arbitrage can be bifurcated into two types- Deterministic Arbitrage and Statistical Arbitrage Implied Volatility Deterministic Arbitrage
In deterministic arbitrage a sure profit can be obtained from being long some securities and short others ssss Example:
1. Cash and carry Arbitrage
2. Reverse Cash and Carry Arbitrage
Long on stock, Buy Put View: Extremely bullish Statistical Arbitrage
Statistical Arbitrage attempts to profit from pricing inefficiencies identified with
mathematical models. Statistical arbitrage attempts to profit from the probability that prices will move toward a historical average. Unlike Deterministic arbitrage, statistical arbitrage has risk.
Example:
1. Pair Strategy Arbitrage
Basis I- Cash and Carry Arbitrage
Cash and carry arbitrage entails making profit from the price differential between cash and futures market, when the basis is positive (Future is quoting at a premium).
Basis = Futures price- Cash Price
During the month basis can turn in to premium or discount. However as time decays future price starts converging cash price and eventually expire at the
Spot Price Future Price closing of cash price (VWAP) on expiry.
Profit: (Future price- Cash Price)*Qty
Illustration 1
Suppose Larsen & Turbo November future is quoting at a premium of Rs.25.00.
Mr. Shah is a conservative investor and wants to make a risk less profit. He can Karun Mutha execute the following trade. Lot size: 200 Sr. Vice President& Head Derivatives Tel +91-22-67897833 Initiation Reversal Email: Karun.mutha@hsbcinv.com Action Scrip Type Yield(%) Days Price Price
Page 1 Derivative Classroom Arbitrage- Series VIII
Derivative Classroom -Series V
Long on stock, sell a call option II- Reverse Cash and Carry Arbitrage View: Neutral/ moderately bullish Reverse Cash and Carry arbitrage opportunity arises when future is quoting at a discount to cash price.
Profit = (Cash price of stock – Future price of Stock) * Qty.
Implied Volatility Profit: (Cash Price of stock- Future Illustration II Price of stock) * Qty Suppose Mr. Mehta has 1500 shares of Sesa Goa. Currently Sesa Goa is quoting ssss at a discount of Rs.10.00. Following trade can be executed
Initiation Reversal Action Scrip Type Yield(%) Days Price Price
Buy LT Futures 335.00 290.00
Sell LT Cash 345.00 290.00 24.18 30.00
Difference 10.00 0.00
III-Pair Strategy Arbitrage
As a trading strategy, statistical arbitrage is a quantitative and computational
approach to equity trading. It involves data mining and statistical methods.
Pair trading strategy is one of the statistical arbitrage, in which stocks are put into pairs based on quantitative simulation or market-based similarities. When one stock in a pair outperforms the other, the poorer performing stock is bought long with the expectation that it will climb towards its outperforming partner, the other is sold short. Example:
1. Buy Tata Steel- Sell Sail
2. Buy Infosys-Sell Wipro
3. Buy HDFC – Sell Rel Capital
IV-Corporate Action based Arbitrage
Corporate action like Open Offer, Buy back, Mergers and Acquisition too provide various arbitrage opportunities. In open offer and buy back risk – reward is determined based on acceptance ratio and we can hedged the likely unaccepted Buying a lower strike Call and selling shares using futures contract. Profitability varies depending on the purchase higher strike call price of shares, days for acceptance and acceptance ratio.
Disclosure HSBC InvestDirect Securities (India) Limited (“HISL”), its associate and group companies, its directors, associates and employees may have various positions in any of the stocks, securities and financial. Instruments dealt in this document or may make sale or purchase or other deals in the securities from time to time or may deal in other securities of the companies / organizations described in this document.
Certification The views and opinions expressed by the author in the document are his own and do not reflect the views of HSBC InvestDirect Securities (India) Limited or any of its associate and group companies.
Disclaimer Clause The above is for customer information only and does not constitute investment advice or an offer to purchase or subscribe for any investment. This document is not directed to or intended for display, downloading, printing, reproducing or for distribution to or use by any person or entity who is a citizen or resident or located in any locality, state, country or other jurisdiction where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or would subject HSBC InvestDirect Securities (India) Limited (HISL) or its associates or group companies to any registration or licensing requirement within such jurisdiction. If this document is inadvertently sent or has reached any individual in such country, the same may be ignored and brought to the attention of the sender. This document may not be reproduced, distributed or published for any purpose without prior written approval of HISL.
This document is not intended to provide legal, accounting or tax advice and should not be relied upon in that regard. Persons accessing this document are advised to obtain appropriate legal, accounting or tax advice where necessary. Financial advice provided has not been prepared taking into account the particular investment objectives, financial situation and needs of any particular investor. As a result, investors using the advice should assess whether it is appropriate in the light of their own individual circumstances before acting on it.
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