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  #1  
Old 21st June 2008, 11:50 AM
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Default Arbitrage and Hedging via Options



Hello,

Can anyone help me in arbitrage, or sensible hedging using Stock options. (The last time I had read about arbitrage was in a pdf article known as Stocks Made Simple does anyone know where to find this article). If so please let me know regards.

Myfuturestock
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  #2  
Old 21st June 2008, 02:25 PM
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Default Covered Call

There could be various method for such arbitration.
Let's start with "Covered Call".

Take the example of TTML:

- Cash / Spot Price is Rs.28/-

- 31 July Call
Strike Price Rs.30/-
Premium Rs. 2.10
Lot Size: 5225

You can buy 5225 shares of TTML @ Rs.28/- and sell July Call of Strike price of Rs.30/- @Rs. 2.10

Now there are following possibilities:

1. Price will rise:
Let the price rise to any level.
You will have maximum profit upto Rs.21423 (i.e. 14.65%)

2. Price will remain same:
You will have profit of Rs.10973/- (i.e. 7.5%)

3. Price will reduce:
You have down-side protection upto 7.5% i.e. price level of 25.90
Thus you can unwind both positions if price comes below Rs.26/-.

I would avoid trying this method in current market situation as we are in confirmed bear market.
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Old 21st June 2008, 04:13 PM
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Default Covered Put

Another tool for arbitration with options is "Covered-Put".
Here the combination will be: Short a lot in Futures & Short a lot in Put.

Let's take example of RNRL:

- July Future is Rs.84.20

- 31 July Put
Strike Price Rs.80/-
Premium Rs. 7.15
Lot Size: 1788

You can short 1 lot of RNRL July future @ Rs 84.20 and Short 1 lot of July Put of Strike price of Rs.80/- @Rs. 7.15

Now there will be following possibilities:

1. Price will fall:
Let the price fall to any level.
You will have maximum profit upto Rs 20294 (i.e. 13.48%)

2. Price will remain same:
You will have profit of Rs.12784/- (i.e. 8.49%)

3. Price will rise:
You have up-side protection upto 8.49% i.e. price level of 91.35
Thus you can unwind both positions if price goes above this level.
This stop-loss should be strictly followed to avoid unlimited losses.
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