# Tag Info

30

Consider the standard error, and in particular the distance between the upper and lower limits: $$\Delta = (\bar{x} + SE \cdot \alpha) - (\bar{x} - SE \cdot \alpha) = 2 \cdot SE \cdot \alpha$$ Using the formula for standard error, we can solve for sample size: n = \left(\frac{2 \cdot s \cdot \alpha}{\Delta}\...

12

Setting aside, that it's not pure riskless arbitrage, but rather statistical arbitrage: You can extract the profit by performing continuous delta hedging. If you constantly adjust your hedge position you gain/lose money by delta hedging. Being long option (gamma long), you sell at higher prices and buy at lower ones. Over the course of time you realize ...

12

A similar question for put option has been discussed in this question: Finding Arbitrage in two Puts. Basically, the call option payoff is a convex function of the strike. Then the call option price is also a convex function of the strike. Specifically, let $C(K)$ denote the call option price with strike $K$. Then for $0 < K_1 < K_2$, \begin{align*} ...

10

There are really a few issues here: 1) When do I turn off a model because I believe the model is invalid? This is a subjective call and depends on many things such as how strong the economic reasoning behind the model is, how crowded the space is, and how poorly the model is performing relative to backtest. With regard to the last point, as a rule of ...

9

You ought to have pre-determined "kill" switches, like a maximum allowable drawdown or time-from-high. Ideally you should get an idea of what these values would be from your backtests. When you do shutdown a model, don't just throw away the code. The strategy might not be working at the moment, but it could come back in the future. I just heard that models ...

9

The "price protection" refers to RegNMS in the US. A stock exchange that does not have the best price must route all order flow to the exchange that does. The SIP in the figure is a consolidated feed that lists the best price among all exchanges. Consider this example: a broker sends a market order to buy JNJ to NYSE where the best offer is \$86.97. However,... 8 An index is just an abstract concept and does not hold securities. Hence no source of revenue from lending them. A portfolio mirroring an index holds the securities and can in fact generate revenue by loaning the securities to others wanting to short the stocks. This provides a positive bias. That is often offset by a negative bias when the index ... 8 Neither. Black--Scholes says nothing about the parameter values:$\mu$and$\sigma.$A very large$\mu$and very small$\sigma$is very unlikely to actually occur in the market and if it did you could make money with high probability without using option contracts. BS simply says that if the market follows a certain process then a certain option price is ... 7 Short answer: yes. Long answer: the challenge in trading these things, like you mentioned, is that each contract is not perfectly hedgable. This is an intentional choice made by the exchanges that list these products, so that they can provide an incentive to trading firms(locals) to provide liquidity for these new products and help boost trading volume. ... 7 The option is a contract that gives you the right to buy the stock in one year for 18. Today people are trading the stock for 20, so you can sell the stock short for 20 today. Selling the stock short means someone will give you 20 cash today in return for a stock IOU, where you are obligated to deliver the stock to them on a later date. So you get 20 cash ... 7 This is called on the run/off the run arbitrage, a type of convergence trade. The basic idea is that as the liquidity premium disappears for the on-the-run issue, the price will fall and converge to the price of previous issues. Here are a couple papers - http://people.stern.nyu.edu/lpederse/courses/LAP/papers/SearchBargaining/VayanosWeill.pdf http://... 7 In the derivatives context, "arbitrage free" means almost surely for the probability measure under consideration. This is in opposition with statistical arbitrage used at high frequencies for example. More precisely the assumption is that there is no$T\geq 0$and self-financed portfolio$V$such that$V_0 = 0$,$P(V_T < 0) = 0$and$P(V_T > 0) > ...

6

You can use a equity based model. Stop trading when your equity drops below your "X-day" equity moving average, and resume trading when your equity crosses above the "X day" equity moving average. You could also do this by measuring the slope of the curve, and not trading when the slope is statistically below 0. I like this method because it does not tie ...

6

The original Nelson Siegel paper describes a parsimonious model of the term structure using only four or three (if $\lambda_t$ is fixed). Filipovic (1999) proves that this model can never be used in a arbitrage free context, paraphrasing the abstract: We introduce the class of consistent state space processes, which have the property to provide an ...

6

In my mind, there are two questions here: 1) How does DB make money given a zero expense ratio? This is covered by Dirk and Lliane. Basically, DB gets cheap funding and stock loan fees in return for paying marketing / index / hedging costs. The ETF investor gets zero expense ratio in return for taking DB credit risk. 2) Why does it look like the etf ...

6

Are there any other mechanisms at play here which might explain this kind of tracking error? Dirk is right, you often lend the titles internally or not, etc. You can also write calls for your index, this is not orthodox, but it's ETF, there is no orthodoxy there... Edit : With the graph and given the outperforming is seasonnal (around May), I think we can ...

6

This depends a little bit on your definition of volatility arbitrage but in general what is meant is a strategy that takes advantage of the difference between implied volatility and realized volatility. Normally you receive implied variance and pay realized variance. This strategy is the classical example of picking up nickles in front of a steamroller ...

6

The main problem is that you cannot achieve Libor in the markets. So the old-fashioned method of discounting at Libor doesn't work any more. As an example, if you compound up the 3m Libor with today's price on a 3x6 FRA, you won't get 6m Libor. Traditionally, that would mean arbitrage, but these days it's just a fact of life. You cannot achieve 3m Libor for ...

5

On Bloomberg. Go to ETF -> holdings and type "97 Enter".

5

Interesting question! I don't think you will get very far just using mid prices, though...any sufficiently sensitive test will flag nearly every situation as an arbitrage since $A_\text{mid}+B_\text{mid} \neq (A+B)_\text{mid}$ in most cases. Instead, what about viewing each price set as a dimension in $n$-dimensional space? The arbitrages occur if the ...

5

Fatih Yilmaz, formerly of Bank of America (currently BlueGold), has a piece called "Imaginal Spreads and Pairs Trading" on exactly this topic, if you can find it (I couldn't find a copy on the public internet), originally published April 17, 2009. He writes: Academics and industry practitioners generally concentrate on time series aspects of currency ...

5

To see the connection between put-call parity and option price you should read this highly insightful paper by Espen Gaarder Haug & Nassim Nicholas Taleb: Option traders use (very) sophisticated heuristics, never the Blackâ€“ Scholesâ€“Merton formula It shows how you can heuristically derive option pricing formulas by adapting the tails and skewness ...

5

Both premiums are actually always positive by definition. The difference will be positive when the forward price exceeds the strike and vice versa.

5

I typically have several tests. Like Ralph Winters said, one calculation to use is the equity curve. I use "...equity curve slope must be greater than x1..." to continue using a model. Another test is, "...%wins must be greater than x2...". Another is, "...average %return per winning transaction must be greater than x3...". Another is "...%return per ...

5

I am not sure why your question had so many upvotes because in currency markets anything else but triangular arbitrage does not exist. What is a quadrangular arb, I have never heard of it despite having traded fx among other asset classes for over ten years now. Think about it: Lets say you observe the price of EUR/USD. You can build triangular arbs by ...

5

While triangular arbitrages exists, they are a rare, short lived, and shallow. In several academic datasets they are very rarely seen, mainly for two reasons, market efficiency aside: (1) the time resolution of the data is not tick by tick but aggregated at some level (for example at 1 second intervals), (2) the dataset doesn't include all available quotes ...

5

Yes, there is a software application that you can purchase for $39.99 which stores all your tick data in a highly compressed format while still allowing maximum throughput and lowest latency data queries that I have ever seen. The package provides APIs to all languages under the sun but because they have a special sale going on it comes with the complete ... 5 Not sure why Python is recommended when you clearly ask for a .Net solution (well you may look at IronPython but I do not recommend it given there are much better options, see below), aside the fact that Python is horribly slow even when performing non-mission-critical data analysis and research. Even C# easily runs circles around most python scripts, given ... 5 In three bullet points: Efficiency: the obtained prices maximize assumed utilities of different agents. In their paper "The Valuation of Option Contracts and a Test of Market Efficiency", Cohen, Black and Scholes compare the theoretical value of options to their market price. The efficiency is in this sense: can agents obtain more or less in practice than ... 5 Let$K_1=0$,$K_2=80$, and$K_3=90. Then \begin{align*} K_2 = 1/9 \, K_1 + 8/9 \, K_3. \end{align*} Moreover, \begin{align*} Put(K_2) &= Put(1/9 \, K_1 + 8/9 \, K_3)\\ &< 1/9 \, Put (K_1) + 8/9\, Put(K_3)\\ &= 8/9 \, Put(K_3). \end{align*} TakingK=K_3$and$\lambda = 8/9\$, we have that $$Put(\lambda K) < \lambda Put(K).$$

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