More on equity/options arbitrage. In the last example, I said it was important to consider the risk/reward (P/L) ratios of equities vs. options. Specifically, to assign a "risk premium" to options based on a higher expected return to make them worth buying. Unless the expected return seems realistic, I prefer equity (common). One possibility is to buy the common and swap for calls if the price drops.
In the previous example (based on SDL's Friday closing price of 196), 81K would have bought you 10 Dec150 calls (at $8100 apiece) or 414 shares of common. Right now, with SDLI at 172 1/2, you could buy those same options for $6437.50 apiece. So if you bought 414 common at 196, you could sell them for 172 1/2, recording a short-term loss of $9729. You could then use the remaining $71,271 to buy 11 Dec150 calls. So even though you "lost" almost 10K on the common, you "gained" 10% more calls than you would have if you'd bought them when SDLI was at 196.
Personally, I still wouldn't make a common-for-calls swap at this price, but I thought it was interesting, given SDL's price action today, to look at why it is good to save call buying for oversold situations only (in my opinion). |
