Finding Arbitrage Opportunities With Solar Stocks: SolarCity

| About: SolarCity Corp. (SCTY)


Recent volatility in solar stocks has created a skew towards downside: puts have become significantly more expensive than calls for the same strike prices.

The difference in the mentioned options pricing has given an opportunity for arbitrageurs.

In this article, I am discussing a trade that involves the call-put parity equation and allows to earn a decent risk-adjusted profit over one month.

​Contrary to the fears that the recent demise of SunEdison's (NYSE:SUNE) stock would spread over the entire solar sector, shares of SolarCity (NASDAQ:SCTY), Elon Musk's child, are up over 5% today:

Click to enlarge

(Source: TD Waterhouse)

Solar stocks have demonstrated violent volatility recently and I refuse to give any directional forecast on them. In fact, I do not care what direction SolarCity's shares move in the near term because I have identified an arbitrage strategy with the company's stock and its derivatives:

Click to enlarge

(Source: TD Waterhouse)

Note: the above table shows prices for SolarCity's options expiring on April 29, less than a month from now.

The biggest concern with the arbitrage strategy is liquidity. As you can see in the table above, there is not much volume in the at-the-money options even with such a close expiration date.

Nevertheless, small volumes (up to 10 - 20 contracts) will likely get filled by market makers without a considerable loss in the spread. Hence, here is the strategy I propose:

(Source: market data)

In essence, I am offering the same deal ​another contributor talked about two weeks ago with reference to SunEdison: buy the synthetic long and sell the actual stock short. This transaction results in an immediate credit balance of $25 per share and simultaneously locks in a profit of $1.00 per share:

​​(Source: author's calculations)

In order to prove that this strategy delivers the same profit at any price of the underlying, I modeled outcomes of the stock reaching a range of $0 to $40 per share:

(Source: author's calculations)

The strategy is delta-neutral at initiation and remains so throughout its life. Essentially, I am offering a strategy that will generate a 2.7% return (assuming you need a 150% margin on shorted stocks, like in the case of my broker) in April with virtually no risk (other than the counterparty risk).

The biggest concern here is execution - a lack of liquidity on the market will eat into your margins. I also excluded interest payable to the broker on shorted securities (although it is unlikely to be high due to the short duration of the trade). Based on the return profile above, I recommend dealing with at least 500 shares in order to earn a decent profit after transaction and other fees.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SCTY over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.