The Arbitrage Opportunities, Strategies and Profits of TAIFEX Index Options

Abstract

This paper examines the arbitrage opportunities and profitability of the options /options strategies and the options/futures strategy among TAIEX Options during 2004. The former include the short spread strategy, the convexity strategy, and the box spread strategy, whereas the latter is extended from the put-call-futures parity. In particular, this paper develops early unwinding strategies that have not yet been studied in Taiwan so far. It reflects the capital rationing of arbitrageurs who are burden with margins and initial outlays. For all four strategies examined in the paper, early unwinding significantly exceeds holding to maturity in profitability, and large portions of arbitrage portfolios are even unwound on the same day. The much shorter holding duration helps to significantly unfreeze the limited capital. Moreover, this paper also focuses on the effect of execution lag. Two different execution settings of historical data simulation are made. By comparing the results in realized frequency and profitability, it reveals the misleading nature of naive price matching criteria which assume arbitrage orders to be dealt at the prevailing mispricing quotes could exist in some previous studies. Finally, regression analyses are performed to capture factors affecting the frequency and profitability of arbitrage trading. The level of stock market volatility and the daily number of index opt ion trades positively enhance the frequency and profitability of arbitrage strategies. It shows that the growing number of trades in TAlEX Options until now may help rather facilitate arbitrage trading than contribute to re-correction of misprices.