Hi,
Here are two different ways to create a risk-free trade involving options, which in both cases will definitely return some form of profit (albeit a fairly small actual amount, but still a profit none-the-less).
1. Buy yourself some stock, then sell a long dated (say 12 months until Expiry) at-the-money Call & Buy an at-the-money Put (also 12 months until Expiry). Due to the inclusions of the "risk free" interest rate in the Option Premium calculations, you'll roughly net the equivalent return as the risk free rate over the course of the 12 months, irregardless of what the underlying stock price does. For example, assuming stock XYZ is $20.00 with IV=30%, here are is an example trade:
Buy 1,000 x XYZ Shares @ $20.00
Sell 1 x XYZ $20.00 Call Option @ 289c
Buy 1 x XYZ $20.00 Put Option @ 194c
Net result = 95c profit based on these premiums, which is a guaranteed 5% (approx) return on your investment no matter what happens (although you may need to manage the trade if the sold Calls are in-the-money approaching an ex-dividend date to avoid early exercise. This wouldn't be a problem unless the share did something weird on the actual ex-dividend date, thus messing up the value of your bought Put option).
2. This is a little more complex, but should work fine: Assume stock XYZ is $20.00 with IV=30%. Place following trade, again using 12 month Options:
Sell $20.00 Call @ 289c
Buy $20.50 Call @ 266c
Sell $20.50 Put @ 220c
Buy $20.00 Put @ 194c
Net Result = 49c Credit (i.e. $490.00 per set of contracts), however cost to close will always be 50c (i.e., $500.00). This results in a $10.00 loss per set of contracts. However, being tricky traders who know how the ACH works, we'd structure things in one of the following ways:
(a) Simply leave the full net credit received plus provide $10.00 per set of contracts as security with our Broker, knowing that if we use someone like "Avcol Stockbroking" they'll pay interest at around 5% per annum on our funds even while they are tied up acting as margin cover! This means we've returned about $25.00 in interest after the year, therefore we're about $15.00 in front even after paying the small extra amount to close the position (ignoring brokerage/fees); OR
(b) If we are currently owning shares we could lodge our shareholdings as security for this option position, and use the net credit received to invest at the risk-free cash rate of 5.5% to earn about $27.00 in interest over the 12 months. Once again, this more than makes up for the $10.00 loss we know we are faced with when closing the trade.
Obviously, you'd need to do a large number of contracts to ensure you cover the Brokerage costs and ACH fees. Furthermore, I'd suggest using European style Options so that you know for sure you cannot be Exercised prior to the Expiry Date. Using XJO index options would be perfect as an example.
I trust you'll find this a useful answer to your challenge!
Jason.
P.S. Would anyone like to calculate the actual % return you are really earning on your invested funds (i.e. $10.00 per set of contracts) in scenario 2 above?? You might be in for a surprise!
