Option Trading: Arbitrage in Spreads.
The term “arbitrage” has different meanings depending on context. In financial circles the reference is frequently to a situation where the up front reward is greater then the risk, so it’s always a win. Option trading is a mathematically balanced system where in general higher risk generates greater reward but with a lower probability of winning the reward. The phrase high probability trading comes from trading strategies or philosophies which dictate you trade only high probability of success trades with smaller, but more certain rewards. In general when we set up a high probability trade we usually seek to get a credit of 1/3 the spread between the strikes. Do fir 5$ spreads around $1.65 and for 1$ spread 33 cents. Very rarely we may find a spread where the credit is larger then the spread. In such an instance a reward is guaranteed. This is rare, but this is what it looks like;
I sell a call contracts 5 points above market price. Gross credit $6.15
I buy a call contract 5 points above my sell price for $1.00, net credit $5.15 or $515
My risk is the spread 5 points or $500 minus my credit which is $515, which is negative $15.
So even if I am wrong and I have to pay the whole $500 spread I still make $15.
These are rare and the wide spread suggests illiquidity, meaning the strikes are rarely traded. Which is usually a reason to avoid trading those strikes. Normally you need to trade in and out of positions to profit, but in this case the liquidity is low, so you may have trouble getting in to the trade.
I know sone of you are probably thinking that with a guaranteed credit greater then the risk you want to trade 100 contracts!
Unfortunately, the low liquidity means very few contracts will be traded and your lucky to get 1 or 2 contracts, great if you can get 10.
But remember bears get rich, bulls get rich and pigs get slaughtered.
Don’t be a pig.
✍️ written by Shortsegments
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Thank you for sharing your insights on option trading. I appreciate your time on putting them on steem blockchain so we can always come back to it as a reference someday, knowing it won't be erased from the internet/blockchain. Super great legacy!
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I agree. I have recently started using a Twitter to spread the News of Steem and one of its strong points is permanence of posts and permanence of platform. I tell people you can’t be deplatformed here or banned.
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Hi! @lalai yes that's a good point to promote steem.
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Thank you for explaining this term. I always hear this term, but the context varies so much I didn’t have a clear understanding of it. Now I understand it as a general concept whose actual appearance or substance varies depending on context.
I am also surprised to learn about this trade where the credit is greater then the point spread between the strikes. That is an amazing thing. You know you have a winner going into the trade. It’s sad that it doesn’t occur in liquid markets. I would be wonderfully greedy or piggy and trade 20 contracts. 😂
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