Well, I was delighted and to execute my first arbitrage trade, not sure if I am considered a Junior “Quant”.

The objective is to earn risk free through trades, scanning the market for floating risk free arb. Now I wish I could develop a machine solely for scanning floating prices like these.

This trade involves simultaneously Long the shares and short the In-the-money call option. In Hedge Fund terms, this is called a Relative Value Arbitrage. (Disclaimer: This is after all not a true risk free trade, because it involved using funds from my acct)

Analysis:
On 21 September 2010 10:30am, HPQ shot up from $39.5 to $40. As I am writing this post at 10:48am, HPQ is trading at $40.02.

The trade:
Ignoring the fundamentals of Hewlett-Packard Company (Public, NYSE:HPQ), we are also interested in its derivatives options market. It opened at $39.5, went up to $40 within 1 hour. The Options, HPQ Oct10 39 Call was price around $1.6+. Then it went to $1.7 when it hit a high of $40.05.

As a Call option Buyer
As a buyer, I would buy a HPQ Oct10 39 Call at $1.7. I would then be able to purchase 100 shares of HPQ at $39, but I have the option to exercise this option. If I do, I will be able to buy this at 100 shares at $39. I may then keep this shares, or sell on the open market at $40 (current price). Looking at maths, its stupid to spend $1.70 to a stock at $39, when you should be spending $1 to buy it at $39, since the stock is trading at $40.

As a Call option Seller
As an options seller selling an options to someone else, the other party buying my option will be able to buy the stocks @ my strike price. I am obligated to sell him at $39 per share. This could happen any time from now till expiration around mid October. In order for this Covered call to work, I need to buy 100 shares of HPQ at $40.05, and simultaneously sell/write the contract at $1.7 per contract for 100 shares. If I didn’t purchase 100 shares of HPQ while I wrote the options, I will be known as ‘Naked Call’.

So as a buyer, for $1.70, you have the option of buying 100 shares HPQ at $39. As a seller, I am forced to sell him my HPQ shares should he exercise his option, but I have already pocketed $173, so I am not concerned if he wants to exercise or not. Note that the current price is at $40.

For this arb covered call strategy to work, I bought on the open market 100 shares of HPQ at $40.05. I then sold the options of HPQ Oct10 39 Call at $1.73.

Using Maths:

100 x $40.05 = ($4005) (The money I had to have in order to complete this trade)
1 x $1.73 = $173 (Call option Sold short)

To sell @ $39 if he exercises:
$4005 – $3900 = $105 (amount I will lose if the buyer exercise his call option)

$173 – $105 = $68 (Potential gain locked-in if he exercises)

Now this strategy is suppose to be bullish. There are 2 downsides.

1) The option buyer decides not to exercise his call option. Then HPQ shares slides down. If it slides pass $38.32($40.05 – 1.73) within the expiration date, I will have to buy back the option (which I believe I will still gain), then sell off my 100 shares of HPQ at a lost. But this lost has already been hedged slightly by my options (Call option prices drop if the underlying stock prices move down, and vice versa). From $40 to $38.3, it will take quite a bit of hit, though there is still risk.

2) HPQ shares rallied to $45. The call option’s price will increase, while my profits have been limited because I have to sell the option buyer @$39, irregardless of how much the market price is, no matter how higher the price is, I still pocketed $68.

Summary
I made $173 if the shares of HPQ doesn’t move higher or lower, and definitely profit if it moves higher.

Files under Hedging strategies | 2 Comments | 2 Comments »

This has been the result of a few months of work, defining and refining my models and trading style, and ultimately seeking to have returns of investments. All the learning over the last 2 years has been paid off, while my small little seed starts to grow, perhaps just a minority.

I am introducing my new fund, just to demonstrate the proven record, rather than to keep it secret. The fund name – MezzoFort Diversified Income Fund.

This is the fund’s description: The fund focuses on building high income and yield for investors and such. It seeks to return a huge 0.5% returns per month, that equates to 6% per year, irregardless of the investors entry and exit points. The fund diversifies to a few highest paying industry, including REIT, Energy and other high cash flow funds of funds, with its our own unique investment selection and strategy

Currently its NAV is a small $900, I hope to grow it till $15,000 by the end of year 2010. As the description claims, the strategy has more or less been fixed and locked like this. Very few trades are done, while the ROI has to be maintained. The aim is to have a stable yet income giving, so as to meet the objectives of 1) Yielding higher than bank interest rates, 2) Allows investors to invest without the need for long term lock ups (which is what I hate most)

This fund will have its strategy separated from one of my other fund, that will be introduced later. That will be completely opposed of this, and it will be described in details further.

My blog will start to post its Monthly Performance of this fund, while keeping the positions undisclosed. I will not disclose any positions or strategies included here on this blog, but the build up of these funds requires some of the skills discussed here.

More details of this fund will be written as a fund fact sheet, soon.

Files under Monthly Fund performance | 1 Comment | 1 Comment »