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Risk Arbitrage Opportunities for Stock Index Options

Author

Listed:
  • Thierry Post

    (Graduate School of Business, Nazarbayev University, Astana 01000, Kazakhstan, Department of Economic Modeling, National Analytical Center ‘Analytica,’ Astana 01000, Kazakhstan)

  • Iňaki Rodríguez Longarela

    (Department of Finance, Stockholm Business School, Stockholm University, 106 91 Stockholm, Sweden)

Abstract

To analyze the economic significance of pricing errors of stock index options, a system of linear inequalities is developed that completely characterizes all risk arbitrage opportunities that 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.

Suggested Citation

  • Thierry Post & Iňaki Rodríguez Longarela, 2021. "Risk Arbitrage Opportunities for Stock Index Options," Operations Research, INFORMS, vol. 69(1), pages 100-113, January.
    • Handle: RePEc:inm:oropre:v:69:y:2021:i:1:p:100-113
    DOI: 10.1287/opre.2020.2012
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    References listed on IDEAS

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    Cited by:

    1. Brendan K. Beare, 2023. "Optimal measure preserving derivatives revisited," Mathematical Finance, Wiley Blackwell, vol. 33(2), pages 370-388, April.
    2. Brendan K. Beare & Juwon Seo, 2022. "Stochastic arbitrage with market index options," Papers 2207.00949, arXiv.org, revised Jul 2022.
    3. Fang, Yi & Post, Thierry, 2022. "Optimal portfolio choice for higher-order risk averters," Journal of Banking & Finance, Elsevier, vol. 137(C).
    4. Armstrong, John & Brigo, Damiano, 2022. "Coherent risk measures alone are ineffective in constraining portfolio losses," Journal of Banking & Finance, Elsevier, vol. 140(C).

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