Risk Arbitrage Opportunities for Stock Index Options

44 Pages Posted: 15 May 2018 Last revised: 4 Dec 2019

See all articles by Thierry Post

Thierry Post

Graduate School of Business of Nazarbayev University

Iñaki Rodríguez-Longarela

Stockholm University - Stockholm Business School; UiT-The Arctic University of Norway - School of Business and Economics

Date Written: December 16, 2018

Abstract

To analyze the economic significance of pricing errors of stock index options, a system of linear inequalities is developed which completely characterizes all risk arbitrage opportunities which arise if a well-behaved pricing kernel does not exist. The Stochastic Arbitrage system can account for market imperfections in the form of transactions costs and general portfolio restrictions. An active trading strategy based on the Stochastic Arbitrage system for front-month S&P500 stock index options yields significant abnormal returns out of sample, for small-scale portfolios. However, outperformance seems elusive if the strategy is scaled up and market depth is taken into account.

Keywords: Options Pricing, Risk Arbitrage, Options Trading, Stochastic Dominance, Empirical Likelihood, Linear Programming

JEL Classification: C61, C62, D53, D81, G11, G13

Suggested Citation

Post, Thierry and Rodríguez Longarela, Iñaki, Risk Arbitrage Opportunities for Stock Index Options (December 16, 2018). Available at SSRN: https://ssrn.com/abstract=3174068 or http://dx.doi.org/10.2139/ssrn.3174068

Thierry Post (Contact Author)

Graduate School of Business of Nazarbayev University ( email )

53 Kabanbay Batyra Avenue
Astana, 010000
Kazakhstan

Iñaki Rodríguez Longarela

Stockholm University - Stockholm Business School ( email )

Stockholm
Sweden

UiT-The Arctic University of Norway - School of Business and Economics ( email )

Tromsø, 9037
Norway

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
187
Abstract Views
1,034
rank
169,581
PlumX Metrics