Options Arbitrage

In the options market, arbitrage trades are often performed by firm or floor traders to earn small profits with little or no risk. To setup an arbitrage, the options trader would go long on an underpriced position and sell the equivalent overpriced position.

If puts are overpriced relative to calls, the arbitrager would sell a naked put and offset it by buying a synthetic put. Similarly, when calls are overpriced in relation to puts, one would sell a naked call and buy a synthetic call. The use of synthetic positions are common in options arbitrage strategies. 

The opportunity for arbitrage in options trading rarely exist for individual investors as price discrepancies often appear only for a few moments. However, an important lesson to learn from here is that the actions by floor traders doing reversals and conversions quickly restore the market to equilibrium, keeping the price of calls and puts in line, establishing what is known as the put-call parity.

Conversion and Reversal

Floor traders perform conversions when options are overpriced relative to the underlying asset. When the options are relatively underpriced, traders will do reverse conversions, otherwise known as reversals.

Box Spread

Another common arbitrage strategy in options trading is the box spread where equivalent vertical spread positions are bought and sold for a riskless profit. 

Dividend Arbitrage

Besides conversions, reversals and boxes, there is also the dividend arbitrage strategy which attempts to capture a stock's dividend payout with no risk.

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