Arbitrage is the simultaneous purchase and sale of an asset in order to profit from a difference in the price. It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms. Arbitrage exists as a result of market inefficiencies; it provides a mechanism to ensure prices do not deviate substantially from fair value for long periods of time.
Arbitrage is basically nonexistent in financial markets nowadays with technological advances bringing market efficiencies nearer to 100%. However, Sprint (NYSE:S) has a great opportunity right now to take advantage of some good ol’ fashioned market arbitrage (although it is not the exact definition of arbitrage). Sprint is a company that has been striving to obtain a profitable quarter. This has given the Company a little extra volatility as investors are waiting to gobble it up when it reports a positive earnings quarter. For the meantime, here is how to invest in S:
Right now S stock is trading at $3.25. This presents a great opportunity for an investor to purchase multiple “regular lots” or 100 shares of the company. In turn, this will give the investor the ability to sell multiple covered calls. However, with this unique arbitrage trade we will be selling the next months first in the money call. This trade will have us selling the September 17 $3.00 call for $.40. In making this trade the shares of S will be called away from the investor if the price stays above the $3.00 price tag; which in this case is what we want because this trade gives downside protection to the $3.00 point. This trade will net a profit of $.15 on a $3.25 investment (that is an annualized gain of 55.4%!).
As I mentioned earlier this trade will give us downside protection all the way to $3.00 because either way the stock is getting called away from that point and above. This is why this trade can be better than the basic covered call strategy. It’s a great low risk strategy for the returns that it can produce on this company.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.