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I love arbitrage situations, who doesn't want free money.

I wrote a screener looking for conversion arbitrage situations and was surprised at some of the results. Conversion arbitrage is where you buy the stock and do a synthetic short via the options. I screened the S&P 500 and found that you can make over 4% per year with no risk of a loss.

Here's how it works. You buy 100 shares of the underlying, then do a synthetic short at the same strike. For example, I just made the following trade.

Buy 100 GE
Buy 1 GE200117P18
Sell 1 GE200117C18

I just made this transaction for $17.56/share ($17.58 after commissions). What is interesting is that I am guaranteed $18/share two years from now, plus there is a bonus in that I also receive dividends from GE, which are currently projected to be $.96 over the two years. GE just cut their dividend, so it is unlikely they will cut it again soon.

With GE at $16.85, my return assuming dividends are unchanged is $.96 + $.42 = $1.38 / 16.85 = 8.2% in 2 years risk-free. Interactive brokers margin on this is only $82.5 initial, $72.5 maintenance, so my return on margin is 167%.

This seems to good to be true. Why wouldn't I use leverage to make a big trade on this? Or at a minimum use my cash holdings on this, it pays a lot better than a CD or money market account. If you need the cash, you can always reverse the trade to get out (or keep it on margin). After the next dividend on 2/23, you will likely be able to reverse it at a profit.

I don't see any major risks. In an acquisition, bankruptcy, or if GE skyrockets and someone exercises the call, I should get my $.42/share quicker, but will lose the remaining dividend, so my return may not be the full 8%, but I don't see how the $.42/share is at risk.

Here are the results of the screener, I assume I can get 15% of the bid/ask spread and pay $.01 per share in option commissions. ROI is yearly, debit is the price paid for the conversion. Dividend is expected dividend at current price and next dividend date.


Symbol Expir Strike ROI Profit (Mark) Debit Call price Put Price Dividend
GE 20200117 18 4.14% $ 1.38 (16.79) 17.58 C=2.4045 (2.41/2.44) P=3.195 (3.10/3.20) D=0.96 02/23
AVGO 20200117 410 3.04% $15.84 (262.68) 408.16 C=8.715 (8.50/10.00) P=154.195 (150.70/154.80) D=14 03/16
WDC 20200117 130 3.01% $ 5.13 (85.84) 128.87 C=4.3175 (4.20/5.05) P=47.3475 (46.70/47.45) D=4 03/28
FL 20190118 85 3.00% $ 1.51 (50.69) 84.73 C=1.02 (1.00/1.20) P=35.065 (34.80/35.10) D=1.24 04/19
BBBY 20190118 37 2.98% $ 0.70 (23.80) 37.40 C=0.5565 (0.55/0.66) P=14.155 (12.70/14.40) D=0.6 03/15
WFC 20200117 75 2.94% $ 3.76 (64.41) 74.75 C=4.2275 (4.20/4.45) P=14.5625 (14.00/14.65) D=3.51 02/01

Conversions with no dividends
Symbol Expir Strike ROI Profit (Mark) Debit Call price Put Price
FB 20200117 185 2.39% $ 8.92 (187.63) 176.08 C=36.1475 (36.00/37.05) P=24.595 (23.65/24.75)
FSLR 20200117 90 2.36% $ 3.24 (69.04) 86.76 C=11.465 (11.40/11.90) P=29.1825 (28.45/29.30)
NFLX 20200117 240 2.32% $10.18 (220.42) 229.82 C=41.9925 (41.65/44.00) P=51.395 (50.45/51.55)
CMG 20200117 350 2.32% $15.18 (329.83) 334.82 C=53.75 (53.10/57.50) P=58.74 (55.50/59.30)
AMZN 20200117 1440 2.31% $59.63 (1297.48) 1380.37 C=178.38 (178.00/180.60) P=261.2675 (257.05/262.00)
MU 20190118 55 2.31% $ 0.98 (42.83) 54.02 C=4.0975 (4.10/4.15) P=15.2875 (15.15/15.30)
PYPL 20190118 90 2.26% $ 1.88 (83.93) 88.12 C=8.805 (8.80/8.90) P=12.995 (12.90/13.00)
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https://boards.fool.com/1228/what-am-i-missing-on-synth-shor...

Interesting Scott...there is a thread about this that I started a few days ago! The GE returns are better than what I'd found on BRKB it seems...
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Symbol Expir Strike ROI   Profit (Mark)  Debit Call price           Put Price            Dividend
GE 20200117 18 4.14% $ 1.38 (16.79) 17.58 C=2.4045 (2.41/2.44) P=3.195 (3.10/3.20) D=0.96 02/23

Very interesting. I read the other on the Pro: Very Timely Questions thread, too.

Since I'm using LEAPS call ratio backspreads for my long positions, I holding a lot of cash to back them up. Getting a good return on that while being able to liquidate is when I need it sounds good. However, it does sound like rising rates could cost me at early liquidation.

But with GE, if I can get 4.14% and don't expect rates to hit that during the 2 years to expiration while only tying up the required margin, this could work out really well.

Looking at Bankrate.com, I don't see savings rates higher than 1.6%.

Dangerscott, have you experimented with this at all?

Enjoy,
Brian
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Yes, I decided to go for it. I have been thinking about this obsessively this week, and I see almost no risk. The only true risk of loss I can think of is if the pricing gets even worse and at the same time, the margin goes up dramatically so you are forced to close early. I'm currently thinking of using up to 5% of my margin on this opportunity, so can't imaging being forced to close early.

I also want to make sure that I wouldn't be charged margin interest for this. It looks like as long as the margin is coming from a cash balance, you will not be. I will keep an eye on that as my position grows, and chatted with Interactive Brokers yesterday about how to monitor that.

The crazy thing is the expected two-year return per 100 shares is $145 - $150, but it only uses $75 in portfolio margin. That means you could turn $75K into $150K in two years with almost no risk. I'm still looking for the catch.

I have done about 50 contracts so far, and am looking to add more if I can get a good price -- $.50 - $.55 discount to the current share price. For some reason, my combination trades often don't go through at Interactive Brokers even at the bid and ask, so I have been quickly legging into the 3 sides. So far, the prices haven't moved on me as I have done so, and several times I got price improvements of a few pennies. The first ex-dividend date is Feb 23, and I will make back $12 of the $75 in margin then. I made one trade yesterday at a $.59 discount which is a 4.78% annual return, so if you are patient you can get an extra $.05 - $.10 per share.

I still don't understand why this opportunity is there, but I stopped believing in an efficient market a long time ago, so will try to take advantage of it. If anyone has an explanation or downside I haven't thought of, I would love to hear it before I plunge deeper.

--Scott
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I wonder what the worst case scenario would be if I were to need the cash on short notice, probably when the market is crashing and volatility is high.

My first thought is that the cost to close would get more expensive, but just how bad is it likely to get? How would I estimate that?

Presumably the stock price will have moved, which should actually have the effect of diminishing the TV. That might mean it would counteract the above.

Hmmm...

Thanks,
Brian
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bid-ask spreads are pretty tight, so I don't think it will be bad to get out of. At $.50 time value over two years, that is about $.02/month the pricing should improve, plus you get a $.12 dividend next month, so I'm pretty sure you can get out at a profit in a month unless pricing really moves the other way.

There is also the 2019 LEAPs, they pay about the same return.
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That's good to know. That virtually eliminates the risk.

The profit comes from dividends and the credit from selling the calls and buying the puts, so that would be taxed as short term income, correct?

Thanks,
Brian
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> The profit comes from dividends and the credit from selling the calls and
> buying the puts, so that would be taxed as short term income, correct?

No, thats what makes this even better. Dividends are taxed as long-term capital gains. The bought shares and put would be long term capital gains if held over a year. The short call would be short-term.

Another part of this arbitrage is say GE doubles this year. You could choose to close out the losing synthetic short on Dec 31st at a short-term loss, and close the winning portions on the first trading day of the next year (you would be unhedged for that time). That could give you a short-term loss one year earlier than your gain, and would even be a short-term loss on the sold call, and a long-term gain on the shares if held a year.
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Thanks, Scott.

It sounds like a great opportunity.

Thinking this through on my own:
If the stock price goes up a lot, the short call might be exercised and short shares assigned, but that will be offset by the shares already purchased. The put would likely be worthless, but the credit would have been earned plus any dividends to that point. The exercise would probably happen just before a dividend payout (lessening the return a bit). That isn't likely to happen immediately, so several dividend payouts should have occurred, so it would be as if we missed one. (I see that you showed IB initial margin at $82.5, which was per contract.)

If the stock goes down enough that the short call is worth pennies, then the position can be closed early with the credit plus dividends (best done soon after a dividend payout).

In either case, the position can be reopened to repeat, so that is likely to increase return.

This is what the curve looks like in TOS:
https://drive.google.com/open?id=1fPYeM1zh55tRDWPcX1qJFGkhyi...

The cyan line is at expiration, the purple is now. Return vertical axis, stock price horizontal axis. You can see that it dips into the negative now by about 4 cents. The peak at about $32 is interesting. TOS also shows that changing volatility doesn't hurt us.

I don't see the catch, either. Do you find there is a good time of day to open positions like this?

Enjoy,
Brian
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Very interesting and recommended. Scott, you bring a tremendous amount of interesting insight and ideas to this community. Thank you!
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The crazy thing is the expected two-year return per 100 shares is $145 - $150, but it only uses $75 in portfolio margin. That means you could turn $75K into $150K in two years with almost no risk. I'm still looking for the catch.

Scott...I'm sorry but I just don't understand this. I see how with portfolio margin you would have to keep very little "collateral" as the long position essentially insures the short calls. However don't you still need all the cash to buy the long? Unless you are actually buying on margin?

Thus isn't the return just 4 something percent? If you wouldn't mind with a quick explanation of your margin situation and how you double your money. thanks, Thinkingbig
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I opened 10 contracts at both ETrade and TDA and was able to get complete for a net debit of $17.54 per share. The return at expiration will be $0.46 plus dividends, minus the $0.02 or so for commissions (at ETrade I'm currently paying about $10 + $1/contract, and I will ask for a discount on that).

Per Share Numbers:
                   Initial  Maintenance
Commission Margin Margin
TDA $0.02 $1.80? $1.80 (apparently, checking on that)
ETrade $0.02 $0.77 $0.75

I believe the downside is that if the market is crashing, the pricing to close the position will get more expensive. Basically the attractiveness of the free money gets higher, so it gets more expensive.

Look at it as if we're offering a loan to get "interest", and there is someone on the other side of this transaction that is borrowing and paying "interest". When the market is crashing, those looking to borrow have to pay more interest because everyone is looking for money to cover or buy at lower prices. If we want to sell our "loan" (close our position), we'll have to pay extra for the difference between interest rates. I don't know how much that could be.

I realize that each of the legs of this 3 leg transaction may be with different people, but the effect is the same.

Enjoy,
Brian
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Hi Brian,

(at ETrade I'm currently paying about $10 + $1/contract, and I will ask for a discount on that).

That's way out of date. Look for $6 + 0.50 or less.

See the thread on brokers here lately.

I also got this trade for $17.54 and I'm using an IRA, so no issue with margin.

I wonder how many people are in this latest "Scott". He has to make up for the lack of VIX trading to occupy himself ;-)

Regards,

Bob
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I was looking at leveraging and buying on margin since this is risk-free, but if I do that, I would need to pay the margin interest rate. Interactive Brokers margin is only 2.42% for over $100K, but that would still take quite a chunk out of the 4.5% expected return and means it is no longer risk free if GE cuts the dividend or if margin interest rates rise.

One thing I still want to play with is different strikes. The cash used is basically the strike price of the synthetic option, so if I can get decent pricing on a 10-strike, the cash required may only be ~$9.70/share vs $17.55 at the 18 strike. Unfortunately that strike isn't very liquid. That does bump the yearly ROI to 5.4% on the 10 strike if I use the cash paid as the denominator instead of the share price. However with an in-the-money call, there is a greater chance of dividend poaching before the option expires.

It is still a decent way to beat money market and other short-term interest rates and to park cash for a year or two, but I'll have to look more into whether it is still worth using leverage for larger gains.
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I got in at $17.45/share. Thanks, Scott, I'm continually amazed at your screening efforts and analysis...
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I was able to buy a 10-strike GE 2020 conversion for $9.50 after commission. It took some effort to get that price and I had to leg into it (although I made all 3 trades within a few seconds, so didn't benefit from price movement). If my assumption is correct that this only reduces my cash by $9.50/share, then this is a 7.81% yearly ROI if GE's dividend stays the same.

$.50 profit + $.96 dividend / $9.50 cash outlay * (365 days/year / 718 days) = 7.81% yearly return on investment.

It is also a 3.96% return assuming the dividends in the next 4 months are paid and are then cut to $0, so it looks like there may still be opportunity for leveraging this for greater returns.
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Thanks for the idea of lowering the strikes Scott, 7 percent is worth doing I think. Of course if we have a serious correction or better yet an true 20% bear market I rather put the cash into equities. My expected equity return from market highs is less than 7.81% but at a 20% lower market I'd favor equities over even 7.8% return on a sure thing.

I guess the strength of this "parking area" for cash is that if you need the money you should be able to get it out at little to no loss and depending on timing of dividends even some gain.

This is WAY better than the 2.7% yield I'd found on BRKB...way better.

BTW--what percent unencumbered cash are you right now? I'm 10% in my taxable account and 20% in my wife's Roth. I'd rather get the cash in the roth working. Guess I could do this in the Roth. It's basically just a covered call with a long put, just need to buy back the call before selling the stock. though I like the idea of (if the stock goes up) booking long term gains and short term losses.

Finally--have you rerun your screen and is GE still coming up the winner?

Thanks again...Thinkingbig (Gene)
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I was never able to get $9.5 so I eventually ended up opening 30 contracts of a 10 strike 2020 conversion for $9.6....little lower return than you got but I’ve got more cash to put to work if rates get better....additionally though I’m starting smaller because the recent sell off makes me want to have some dry powder in case opportunities open up...so far it’s nothing but if it turns into a bear market then 7% “interest” may be less attractive than good prices on good companies...thanks again for the idea...thinkingbig
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I took a look at where I am with this GE Collar opened on 1/29/18 now.

GE $18 Call $18 Put Net
$16.16495 -$2.22225 $3.61767 $17.56
$14.46 -$1.53 $4.47 $17.44

GE has dropped from 16.16 to 14.46, or down $1.70.
The syn short has gone from $1.40 to $2.94 or up $1.54.

So the net is down $.16. With the $.12 Feb dividend gives down $.04. I suppose that is due to increased volatility.

If gets down to about $10.50, the chart shows 65% return with a diminishing rate of return so it may make sense to close early and reopen a new position with lower strikes.

Enjoy,
Brian
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Brian...indeed the lower the strike on the syn short generally the higher return on the overall position. This is mostly a function of the lower cash outlay to set up the whole position while still receiving the full dividend. I looked at the lowest strike available at one point (I think it was $3) and with realistic assumptions about what I could actually sell the call and buy the put the return if held for 7 dividend payments was over 11% annually. However I did not set it up because with such a deep in the money sold call I was afraid that I would constanty keep getting dividend poached and did not want to deal with that.
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Scott,

Dividends are taxed as ordinary income, not capital gains. For most people, the marginal ordinary income tax rate is higher than the capital gains rate, but YMMV.

Also, order the scenario you described, closing out the losing leg would give you a short term loss, but can also reset your gains clock on the underlying shares. It is not guaranteed that the shares would get long term treatment.

David.
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Hi David,

Dividends are taxed as ordinary income, not capital gains.

As I understand things, NOT TAX ADVICE, there are qualified dividends and ordinary dividends that are taxed at different rates. Complicated. Part of why I'm happy to pay my CPA to fill out the tax forms for me each year. (Perhaps in March this year ... I already have my K-1 forms).

phooL on!

Lon.
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there are qualified dividends and ordinary dividends that are taxed at different rates

and I believe that GE's entire $.48 annual dividend is qualified.
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An update on my GE conversion arbitrage.

I ended up rolling down my strikes to 5 and 8 because the returns were 10-11% per year on the 5 strike vs 8% on the 8 strike and 7% on the 10 strike. Yesterday almost half of my 5 strike calls were assigned as the ex-div date is today.

I still have all of my 8 strike conversion, and over half of my 5-strike, and will receive a $.12 quarterly dividend per share on them.

Of the ones that were assigned, I bought most of the 5-strike conversions on Mar 23rd for $4.85. I still own the GE 2020 5P which is worth about $.08, assuming I can sell it for $.07 after commissions, that means I made $.22 on a $4.85 investment in 84 days, which is 4.5% and works out to a yearly ROI of .22 / 4.85 * (365 /84) = 19.7%.

Pretty impressive for a risk-free investment. Since liquidity is very poor on the 5-strike, I started to write a program to automate trading, but haven't gotten around to working on it in a while. If I can't sell another 5C at a good price, I may go back up to an 8 or 10 strike.

--Scott
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Hi Scott,

Thanks for the update on GE. I have held my 18 strike synthetic short along with the stock since Jan 29:

Margin required has consistently been $0.75/sh

I anticipate the dividend from yesterday in a couple of months:
Dividend GE CASH DIV $0.12/sh (received 6/15/18)

As expected, the change in stock and syn short position net is zero:
GE Stock -$2.86/sh
GE Call $1.40/sh
GE Put $1.46/sh
Net $0

I reported when I set this up:
http://boards.fool.com/1228/i-opened-10-contracts-at-both-et...
I opened 10 contracts at both ETrade and TDA and was able to get complete for a net debit of $17.54 per share. The return at expiration will be $0.46 plus dividends, minus the $0.02 or so for commissions.

Cost to open was $17.56 per share with commissions.

If I closed now, midpoint is 17.59/sh, so if I were able to close for 17.49/sh with $.02/sh commission (so $17.47 or $0.08 loss), and pocket $.24 in dividends, the ROM would be $.16/.75 = 21.33% in about 5 months, or about 51% ROM annualized. Please check my math on that. Obviously the spread and commissions have a big affect on the net return.

I will hold another 3 months to see if the annual return improves or degrades.

To optimize this strategy, I'm considering opening a position a few weeks before receiving the dividend then planning to close it after the first or second dividend is received. This maximizes the affect of the dividend. I would do this quarterly, so I would have 2 or 3 overlapping positions. But since there is low to zero risk on this, overlapping doesn't matter (though it affects margin during the overlap). Am I missing anything?

And I will consider using lower strikes, but not so low that they get poached, which might give better returns.

Note that when I checked on March 8th (as I reported at the time), my net to close the position including dividends was a $.04 loss. That may have been due to the market volatility at the time, but indicates that positions might not be able to be closed profitably soon after the dividend is received, and why sometimes it will make sense to close after the second dividend is received.

Another factor is that if I hold for longer than a year, any loss on the stock and gain on the put will be long term capital gains, while any loss on the short call will be short term capital gains.

Note about qualified dividends that are taxed as capital gains (since this was discussed earlier in this thread and has an impact on this strategy):

Qualified dividends are taxed at much lower rates, which are actually the same rates as long-term capital gains.
...
for a dividend to be qualified, it must be paid by a U.S. corporation, or by a foreign corporation that is readily traded on a major U.S. exchange ... Also, you must have held the stock for more than 60 days of the 121-day period around the ex-dividend date (60 days before through 60 days after).

https://www.fool.com/investing/general/2015/03/06/3-prevaili...

Enjoy,
Brian
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Since I still have my GE200117P5 after my calls were poached, I placed a GTC order to try to get back in this position. I did a
-1 GE200117C5, +100 GE @ $4.81
This is selling $.19 in time value, which would more than make up for the $.12 dividend that got poached from me two weeks ago.

I monitor all the trades for GE 5Cs and was hoping that order would let me pick off any of the high ones I occasionally see. Unfortunately it did not, as a 20-lot trade went through with $.42 of time value this morning.

price  size   bid/  ask bidsz asksz (u_bid/u_ask) tm vl update time
8.45 20 7.00/ 8.65 3481 250 (13.02/13.03) 0.42 20180620 06:49:13 PDT

The lucky seller could generate a 14.7% annual return through 2020 on a conversion arbitrage if GE keeps its dividend.
GE200117C5 20 20180620 06:49:13 D=0.26, 8.45 (13.02/13.03), P=0.02/0.14 14.680%

My order did partially fill later today, so I was able to get my position size back up. Unfortunately IB does not have a way to place an order based on time value so I can say I want to sell a 5C with at least $.20 in time value and try to pick off these occasional great priced trades. Still debating whether it is worth writing a trading program via there API to capture those opportunities.
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I wrote:
If I closed now, midpoint is 17.59/sh, so if I were able to close for 17.49/sh with $.02/sh commission (so $17.47 or $0.08 loss), and pocket $.24 in dividends, the ROM would be $.16/.75 = 21.33% in about 5 months, or about 51% ROM annualized. Please check my math on that. Obviously the spread and commissions have a big affect on the net return.

Note that if I hold to the end, the total return is $0.96/sh (dividends) and $.44/sh difference between $18 strike and $17.56/sh cost to set up the position, or $1.40. ROM is $1.40/.75 = 187%, over 2 years CAGR is 69.71%.

So holding until expiration seems to be best -- and requires way less time and effort.

The biggest problem with this trade is that you'd need to buy 100 contracts to earn $14,000 (requiring $7,500 in margin). 1029 Jan '20 $18 contracts traded today. But if you were to set up a 1000 contract position, the price might be significantly affected by this volume, so that might require trading over several days. Even small affects on the price could noticeably affect the return.

The other problem is if GE cuts the dividend, but the position could be exited at that point.

Enjoy,
Brian
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Hi Scott,

thank you for bringing in the other thread this original back to our attention. I fear i did not understand it right. So far i found as well no risk in it. But this does not mean anything.


A few questions:

1. instead of buying shares, why not setup a synth long? Ok there are the missing dividends, but there is a lot less cash needed.
2. for the CC, why not use shorter term Cc to repeat income?

3. I don't see volatility hurting as well, or do you have different experience?

best wishes
J.
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> 1. instead of buying shares, why not setup a synth long?
The basis of the strategy is that the combination of a long stock plus synthetic short pays you a guaranteed return. One reason for this is a long call saves cash, so you need to pay additional to make up for the money that cash could earn. Doing a combination of synth long and synth short is unlikely to pay much, although it is an interesting idea to look at.

> 2. for the CC, why not use shorter term Cc to repeat income?
In my case I am looking for risk-free investments, and using a shorter term sold call would require paying additional capital up front that may not be made up if the stock rises.

As I mentioned in one post, if you can find a 5% risk free arb, and margin it twice over at IB current interest rates, you can turn that into a 9.1% risk-free guaranteed return, or higher than Northstar. I don't think 5% is easy to find, but I do think opportunities occasionally pop up. I am going to keep looking for these opportunities and if I find enough, I may start selling off more of my portfolio to convert to conversion arbitrage, or even start using margin for it.
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Hi Scott,

yes i know these are modifications.

Using Synth long
I agree it all depends on price. But when the price is right, then i think it can be used. The idea is, to use the leverage and the "free" money for investing i different equities or invest in more contracts.

using more short time CC

yes it is more risk and we need more cash upfront. On the other hand, there is the chance to generate more money from the CC.

and maybe we can raise the strike of the put. But maybe it cost to much money.
These modification needing a good backtesting before using it.

In my thinking no strategy is without risk and there is no free money out there. But we have not found the risk so far.

best wishes
J.
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Hello again Fools! 

Sorry I've been gone for so long & nice to be back!  I "lurked" for nearly 2 years, prohibited from posting while I was at a hedge fund on the tech side.  Now I'm back to silicon valley...and back to the Pro community.  (My screen name used to be StanfordMBAFool…)

And sheesh - what a set of changes - I return to a closed down Pro?!?  I'm still not sure what to make of that, but if anything keeps me here, it will be the community.  One New Year's resolution is to spend more time managing my investments, contributing to the community. 

Anyway...on the topic at hand - I wonder if there's any further thinking / results on the conversion arbitrage idea?

I put together my own conversion arb screener for grins - getting quotes from Tradier & IEX (I'm a sucker for free data, and inertia's kept me at Fidelity with it's nonexistent API, instead of IB).

Use at your own risk, of course, but it seems to be generating reasonable data. 

The likelihood of capturing the whole chain of dividends is low - especially for the deepest OTM options, so I evaluated all strikes less than the current market price.  For some, better returns were found above lowest strike LEAP.   

Any theories on what makes a good candidate?


Strike	Call   Spread	        Call TV	Put     Put Spread	DebittoOpen#Divs Div $ Tot Proceeds	Exp Gain	Ret on Cost	Ann Return
3	6.35	(6.00/6.70)	0.41	0.225	(0.15/0.30)	-2.815	8	0.08	3.08	0.265	9.41%	4.58%
5	4.75	(4.55/4.95)	0.81	0.535	(0.51/0.56)	-4.725	8	0.08	5.08	0.355	7.51%	3.67%
8	2.85	(2.80/2.90)	1.91	1.49	(1.42/1.56)	-7.58	8	0.08	8.08	0.5	6.60%	3.23%
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No. of Recommendations: 3
Hello again Fools! 

Sorry I've been gone for so long & nice to be back!  I "lurked" for nearly 2 years, prohibited from
posting while I was at a hedge fund on the tech side.  Now I'm back to silicon valley...and back to
the Pro community.  (My screen name used to be StanfordMBAFool…)

And sheesh - what a set of changes - I return to a closed down Pro?!?  I'm still not sure what to
make of that, but if anything keeps me here, it will be the community.  One New Year's resolution
is to spend more time managing my investments, contributing to the community. 

Anyway...on the topic at hand - I wonder if there's any further thinking / results on the
conversion arbitrage idea?

I put together my own screener for grins - pulling quotes from Tradier & IEX (I'm a
sucker for free data, and inertia's kept me at Fidelity with it's nonexistent API, instead of IB - 
another 2019 resolution).

Use at your own risk, of course, but it seems to be generating reasonable data. 

The likelihood of capturing the whole chain of dividends is low - especially for the deepest OTM
options, so I evaluated all strikes less than the current market price.  For some, better returns
were found above lowest strike LEAP.   

Any theories on what makes a good equity candidate?
Factors for success?  (e.g., to avoiding dividend poaching, is it best to go for low/zero
div stocks?  If not, I'd ensure the TV of the sold call is larger than the dividend, so you're
likely to get through at least dividend event #1)

Can this go awry if the stock is called away and you owe the dividend?  
Seems interesting idea if the liquidity is there and you can get the mid-point/good prices. 

(@dangerscott - Thanks for the inspiration. Imitation is the sincerest form of flattery...any 
other inspirations?? )

GE: $8.94
Strike	Call   Spread	        Call-TV	Put     Put Spread	Debit   #Divs   Div $   Sale$	Gain$	GainPct	AnnPct
3	$6.35	(6.00/6.70)	0.41	$0.23	(0.15/0.30)	($2.82)	8	0.080	$3.08	0.265	9.41%	4.58%
5	$4.75	(4.55/4.95)	0.81	$0.54	(0.51/0.56)	($4.73)	8	0.080	$5.08	0.355	7.51%	3.67%
8	$2.85	(2.80/2.90)	1.91	$1.49	(1.42/1.56)	($7.58)	8	0.080	$8.08	0.500	6.60%	3.23%

FB: $143.8
Strike	Call   Spread	        Call-TV	Put     Put Spread	Debit           #Divs   Div $   Sale$	Gain$	GainPct	AnnPct
20	$125.10	(123.00/127.20)	1.3	$0.15	(0.08/0.22)	($18.85)	0	0	$20.00	1.15	6.10%	2.99%
25	$120.45	(118.50/122.40)	1.65	$0.19	(0.02/0.35)	($23.54)	0	0	$25.00	1.465	6.22%	3.05%
30	$115.65	(113.50/117.80)	1.85	$0.36	(0.21/0.51)	($28.51)	0	0	$30.00	1.49	5.23%	2.57%
35	$111.10	(109.00/113.20)	2.3	$0.47	(0.24/0.69)	($33.17)	0	0	$35.00	1.835	5.53%	2.72%
40	$106.65	(104.50/108.80)	2.85	$0.55	(0.21/0.89)	($37.70)	0	0	$40.00	2.30	6.10%	2.99%
45	$102.10	(100.00/104.20)	3.3	$0.73	(0.32/1.14)	($42.43)	0	0	$45.00	2.57	6.06%	2.97%

NFLX: 337.59
130	$223.00	(221.00/225.00)	15.41	$6.80	(6.25/7.35)	($121.39)	0	0	$130.00	8.61	7.09%	3.47%
135	$219.00	(217.00/221.00)	16.41	$6.50	(5.00/8.00)	($125.09)	0	0	$135.00	9.91	7.92%	3.87%
140	$215.00	(213.00/217.00)	17.41	$7.03	(5.50/8.55)	($129.62)	0	0	$140.00	10.385	8.01%	3.91%
145	$211.00	(209.00/213.00)	18.41	$7.95	(6.50/9.40)	($134.54)	0	0	$145.00	10.46	7.77%	3.80%
150	$206.75	(204.50/209.00)	19.16	$8.13	(7.10/9.15)	($138.97)	0	0	$150.00	11.035	7.94%	3.88%
155	$202.75	(200.50/205.00)	20.16	$9.00	(7.50/10.50)	($143.84)	0	0	$155.00	11.16	7.76%	3.79%
160	$198.75	(196.50/201.00)	21.16	$10.00	(8.50/11.50)	($148.84)	0	0	$160.00	11.16	7.50%	3.67%
165	$194.75	(192.50/197.00)	22.16	$11.35	(10.70/12.00)	($154.19)	0	0	$165.00	10.81	7.01%	3.43%

MMM: 192.21
105	$87.25	(85.00/89.50)	0.04	$1.76	(0.80/2.72)	($106.72)	8	10.880	$115.88	9.160	8.58%	4.19%
110	$82.50	(80.00/85.00)	0.29	$2.01	(0.97/3.05)	($111.72)	8	10.880	$120.88	9.160	8.20%	4.00%
115	$78.00	(75.50/80.50)	0.79	$2.33	(1.20/3.45)	($116.54)	8	10.880	$125.88	9.345	8.02%	3.92%
120	$72.98	(70.50/75.45)	0.765	$2.85	(1.70/4.00)	($122.09)	8	10.880	$130.88	8.795	7.20%	3.52%
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Sorry for the double-post!

...and to answer my own question, this doesn't necessarily go awry if the stock is called away. You end up empty, not short the shares (as happens sometimes with diagonals...)

In any case, still trying to find any unforeseen risk.

Gaming this out, I would
1) start with a buy-write for the shares and short calls, then
2) buy the puts separately.

I would wait to place the order for the puts until after the buy-write executes. That leaves a small risk that the liquidity isn't there, or that the pricing isn't near the midpoint for the puts.

Worst case, plan for the all the shares to be called away before the first dividend. If that gives you a reasonable-return, great.

I think as long as the sold TV in the call is more than the purchased TV in the put, you should at least end up ~even.

I'm thinking there's also a variant where the position is designed to get called away on the ex-div date...in any case, i'll keep searching for scenarios that are reasonable.
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CardinalFool, good to have you back!

What expirations dates are you using?
Something close to the next ex-dividend date?
Have you tried going further out, to farthest dated expirations?

Peace and joy,
Brian
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Thanks Brian! To your question, I used the farthest dated expirations - Jan 15, 2021.

Today, I got "creative", and tried something in the same vein by this, but designed to be called away for a quick return.

ORCL goes Ex-Div tomorrow. Trading ~$48.

Just before the close, the Jan 2021 25 Call had ~0.12 of time value, giving me a debit of 24.88 for a position callable at $25.

Obviously this isn't riskless - There's the non-zero risk ORCL could go bankrupt tonight, but I thought it's pretty close to buying $25 for $24.88. I set this up so I wouldn't be in the position for long. My plan was to buy calls with less time value than the 0.19 dividend - giving an incentive for them to get called away tonight.

That's a seemingly tiny 0.5% overnight return, but that annualizes to >300%/yr

To my surprise... Fidelity executed this for a debit of $24.79! ($24.799 with commission...) Go figure. Sometimes they do better than the ask price. While that's great, the extra time value makes it less likely (but still possible) my stock will get called away. On the positive side, if the calls do get exercised, my overnight returns bump to 0.7% - or 6.7x/yr

If I discover I'm still in this tomorrow, I can
* add the put to make it riskless (not practical for ORCL - the put pricing sinks the return)
* put in a GTC order to exit at 25 for the buy-write
* accept the risk, ride it out until the next dividend, and try again...but that would decrease my returns to .38/24.79 = 6% annualized. Not bad, but not riskless, and not exactly great.

Will keep you posted...
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If you have the time and inclination I’d like the details of your trade. I can’t quite follow from your post. Thanks

Dave B
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> Just before the close, the Jan 2021 25 Call had ~0.12 of time value, giving me a debit of 24.88 for a
> position callable at $25.

So it sounds like you bought the stock and sold the 2021 25C for a total debit of $24.799/share

I see a huge bid/ask spread (22.75/24.80) on the 2021 25C, how did you come up with $.12 of time value? The puts are going for $.53 - $.78, so it will take 3-4 several dividends if you had bought the puts just to break even.

I wouldn't expect your options to be assigned any time soon since the puts have so much time value.
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There's a reasonable chance that my attention to detail failed me here... I was tracking 3 possibilities. My "head" remembers 0.11 time value, but the market tells me it was otherwise. Now I see time value is even higher. Either there was strange pricing just before ex-div date, or I didn't set my limits right. Sigh.

Also - my intent was a little different...

Instead of setting this up truly riskless - a synthetic short + long shares, my "plan" was to find a call likely to get called away before the ex-div date, accepting one day of risk.

That didn't work out exactly as planned...

Shape of the trade to test the theory:
1000 ORCL shares (debit of 48.27), 1 day before Ex-Div, div pmt = 0.19
10 short Calls, @25 strike. (credit of 23.48)
0 puts.

Net debit was 24.799, with commissions.

It hasn't all gone wrong - in 24 hours I received $0.19 dividend on a 24.80 investment. I have a GTC order to exit the position, but that may take a while.

While I'm content to sit on this for a little while, what I did wasn't arbitrage. Instead, it gave me dividends for half the outlay, and a quick payout for div#1 - one day.

The longer I hold this position, the closer my returns approach 2x the ORCL dividend rate (1.5% x 2 = 3% ), so I'll try to get out sooner than later. Now my goal is to avoid the situation where the only one happy is my broker. And for ORCL to stay in business for the next quarter. :-)

Back to the drawing board.
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After dabbling with ORCL dividends and coming away (slightly) wiser but not really richer, 
I went back to the original premise - a risk-free arbitrage trade, with the following structure:

Buy stock in lots of 100
Buy a corresponding synthetic short with a call strike that's deep ITM.  
(e.g., strike << stock price)

The returns come from:
1) Capturing any net time value in the synthetic short
2) Any string of dividends before the stock gets called. 

The premise is this could be levered up for pretty solid risk-free returns. 

I screened a handful of stocks, and came up with this:

F	(As of Jan 19, market closed. F at 8.58, quarterly dividend of 0.15)											
												
Strike	Call    Call$ Spread	TV	Put$     Spread	      EstOpen$	#Divs   Div$	Tot$    Gain$  Return%  Ann%
3	$5.45 	(4.60/6.30)	($0.13)	$0.15 	(0.10/0.20)	($3.28)	9	$1.35 	$4.35 	$1.07 	32.62%	15.23%
5	$3.90 	(3.00/4.80)	$0.32 	$0.36 	(0.29/0.42)	($5.04)	9	$1.35 	$6.35 	$1.32 	26.12%	12.36%
7	$1.98 	(1.86/2.10)	$0.40 	$0.95 	(0.90/0.99)	($7.55)	9	$1.35 	$8.35 	$0.81 	10.67%	5.22%


This looked pretty juicy from a return perspective, but as we all know, it's hard to find free money. 

A few things..

I thought it was curious that both GE and F have stock <10, with a healthy amount of volatility. 
Both have low-strike LEAPs, which might amplify any mis-pricing.  A nickel or 2 on $3 is a big deal.  
A nickel or two on $50, not so much. I'll screen for similar priced stocks.

I also noticed the time value of the call was negative, assuming the call would trade at the mid-point
of the bid-ask spread.  It's not rational pricing to have a negative time-value option.  I suspect that's
an anomaly of low-liquidity options.  A market maker/trader would be happy to BUY something that can be
immediately exercised for a profit, but there's no true supply from rational sellers.  

Similarly, they're happy to SELL something that's egregiously priced, but there's no demand, except 
for the occasional fool(small f) who enters a market order. 

Regardless, these spreads gave me a range of prices where this could be attractive. 

My first attempt:
I put a test order in for 20 F synthetic shorts.  With Fidelity, I can write that as one order, 
ensuring I get both the calls and puts.  (I don't know of any way to order stock + short
call + long put in a single order).  F shares are liquid & easy to purchase once the
short is in-hand.

I had a strict limit - only sell calls with more time value than the value of the dividend (to prevent poaching).

Short story:  No takers this round.  I let the order linger for ~2 hours, then needed to catch a train.

If the returns exist in my spreadsheet, but not the market, this isn't so interesting. 

Not clear - I'll try again next week.  This time I'll keep the call TV positive, 
maybe let it drift a nickel or so below the value of the dividend, but still positive. 

If anyone has better thoughts on setting price limits, or the idea overall, I'm all ears.
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You can't assume you will get anywhere near the midpoint. I wrote my screener assuming the worst case -- buy at the ask, sell at the bid, and $.01/share commission on options. I haven't seen anything over 4.5% for the last few weeks, and around 3.2% with no dividends.
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Makes sense - Worst case is a smarter way to screen... I'll do that going forward.

How frequently are you scanning? Across the whole market, or some subset?
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A few more thoughts, after I made the change to my screen. I notice some of the "bid" prices have negative time value for the call.

That doesn't seem like something you should be willing to sell - the buyer can exercise right away.

Example - For GE a few minutes ago, the stock was at 8.60, bids on the Jan 2021 3 call were $5.30.

A rational buyer would exercise immediately for a debit of 8.30, then turn around and sell those called shares for $8.60 for 0.30 instant profit.

If you're the one assigned, you've lost 0.30 per share immediately.

For an option with a big open interest, my understanding is there's a chance your shares won't be the ones assigned. (e.g., GE, with ~60,00 open contracts). But for a big trade, you're playing the assignment lottery. Especially on options with smaller open interest (e.g., Ford, with only 369 open contracts for the June 2021 3 call).

Screening based on worst case (e.g., ask for buys, bid for sells) guarantees you can execute. That's a good starting point.

But should the screen also target the following?
* calls with positive time value (to avoid immediate exercise)
* calls with time value > the next dividend (to increase the chance you keep the position through one dividend)
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Yes, I also add those filters.

Another one, while not perfect is I assume the chance I get the last dividend is the same as the delta of the sold call. This is because if the call is in the money, it is likely that the last dividend will be worth more than the time value remaining.
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