YRCW - How a Text Book Trading Arb Can Lose You Everything

YRCW is trading $0.74, down 2.2% with IV30™ down 13.4%. The LIVEVOL® Pro Summary is below.



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With the market in ultra slow mode, this is a really interesting stock where an apparent arbitrage is staring us all right in the face... or is it?

Let's skip the company specific details and just get into trading. The Options Tab is included below.



First, the apparent arb:
If one were to sell the Oct 0.5 straddle @ $0.61 then there is no risk to downside stock movement, right? A stock can only go to zero, (so losing $0.50 to the put), but the position collected $0.61, so that's at worst case an $0.11 win.

Ok, fair enough. But what about the upside? Well, one could purchase the Oct 1 calls for $0.06. That would make the net credit on the total trade $0.55. Still no downside risk (same argument), and now there is no risk to the upside stock movement, right? Do the math, it's right, :-p

So, wth? Let's do this trade fricking size!!!

Not quite...

Look at the 0.50 strike synthetic fwd stock price:
Stock = 0.5 + 0.24 (the call) - $0.38 (the put) = $0.36. Yup, and the stock is trading $0.74. In other words, this thing is incredibly hard to borrow (very large negative rate).

So, why does that matter?

How does the same trade (sell straddle buy OTM calls) look if this happens:
Sell 0.5 strike calls
Sell 0.5 strike puts
Buy 1.0 strike calls
---
0.5 calls get exercised.

The position becomes:
Short 0.5 strike put
Long 1.0 strike call
And...
Short stock... uh oh...

The short stock pays a huge negative rate, and even more so, has risk of a buy in. Either way, the short stock can't be maintained. Buying the stock back leaves:

No stock
Short 0.5 strike put
Long 1.0 strike call

Eh hem... That, is not a risk free profit, it's a risk reversal long deltas in a stock that's priced to fwd at $0.36. And who knows what price the stock buy back occurs at.

There you go... An "arb" that could cost you everything... And yes, I see there is more than 8,000 OI (unexercised) in the Oct 0.5 calls... But I also see that over 30,000 have traded today.  So, ya know...

This is trade analysis, not a recommendation.

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