Arbitrage strategies are an essential part of financial markets, allowing traders to exploit price discrepancies between different markets or instruments. This blog post explores synthetic positions and four key arbitrage strategies: conversions, reversals, boxes, and jelly rolls. For more detailed analysis please visit the Rival Systems Options Knowledge Base. 

The Power of Synthetic Positions 

In options trading, synthetic positions play a pivotal role by replicating the economic effects of holding an underlying asset. These positions create unique opportunities for arbitrage—profiting from differences between the market price of an asset and its synthetic counterpart. Arbitrage arises when a contract can be bought in one market at a lower price and simultaneously sold synthetically in another market at a higher price. 

Conversions and Reversals 

  • Conversions: This arbitrage strategy involves creating a synthetic short position by buying the underlying asset while simultaneously selling a call option and buying a put option with the same strike price and expiration. For example, if an underlying asset trades at $103.00 and the combined position of the call and put options deviates from the expected market value, a trader can lock in a profit by executing a conversion at favorable prices. 
  • Reversals: Conversely, a reversal strategy entails selling the underlying asset and setting up a synthetic long position through options. This setup is ideal when synthetic prices are higher than the actual market price, allowing traders to profit from the price differential. 

Arbitrage Example 

Boxes and Rolls 

  • Box Arbitrage A box is a sophisticated form of arbitrage that involves four options: a long call and a short put at one strike price combined with a short call and a long put at another. This strategy locks in a risk-free profit when the spread between the strike prices is less than the difference in premiums. For instance, if the net premium difference equals $10 but the strike prices differ by $15, the arbitrageur stands to gain $5 per share minus transaction costs. 
  • Jelly Rolls or Rolls Jelly rolls involve a combination of conversions and reversals across different expiration dates but at the same strike price. This strategy is used to exploit differences in time value and interest rates between contract months. A trader might buy a March 100 call and sell a June 100 call while also managing puts accordingly. The resulting position is a calendar spread that profits from the net carrying costs between the purchase and sale dates. 

 Arbitrage strategies are essential tools for options traders looking to enhance their trading precision and profitability. By mastering these strategies, traders can capitalize on market inefficiencies without assuming significant risk. For those eager to dive deeper into theoretical models and real-world applications, visiting Rival Systems’ Options Knowledge Base provides a wealth of detailed examples and expert insights.

 

 

This material is meant for educational purposes only. The information, strategies, and examples presented are not to be construed as trading or investment advice. Rival Systems does not endorse or recommend specific trading or investment decisions and users are encouraged to exercise their own judgement and seek professional advice before making any financial decisions.

Users are urged to carefully consider their financial objective, risk tolerance, and level of experience before engaging in trading or investment activities. Rival Systems is not responsible for any inaccuracies, errors, or omissions in the educational content or for any actions taken in reliance on such content.