Risk Arbitrage Opportunities for Stock Index Options

Thierry Post () and Iňaki Rodríguez Longarela ()
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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

Operations Research, 2021, vol. 69, issue 1, 100-113

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.

Keywords: options pricing; risk arbitrage; options trading; stochastic dominance; linear programming (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:oropre:v:69:y:2021:i:1:p:100-113

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