Options Arbitrage for the Masses
Around the cavernous trading floor of the
Chicago Board Options Exchange
, he's known as "608."
Identified only by the code number of the clearing firm he uses, "608" is one of a new breed of individual investors profiting from buying options from one exchange and selling them almost instantaneously on another for more.
This low-rent options arbitrage is flourishing among individual investors in the wake of federal government pressure to list certain options on more than one exchange. It has sparked competition that, so far, has meant better prices for investors. And trigger-happy traders like "608" now have the benefit of technology to find and exploit price differences between exchanges.
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Since multiple listing
began, "you can definitely go shop according to price. You can still get an 1/8 or 1/4 point," says John Mannino, who heads the Philadelphia chapter of the
American Association of Individual Investors
.
"608" Guy and You
That might not seem like big money, but "608" and other individual investors can make fractions of a point on hundreds of trades.
Popular options such as
America Online
(AOL)
TheStreet Recommends
,
Intel
(INTC) - Get Intel Corporation Report
and
Microsoft
(MSFT) - Get Microsoft Corporation Report
began trading on more than one exchange last fall, but the four options trading floors -- the
American
and
Philadelphia
stock exchanges along with the CBOE and
Pacific
-- aren't linked electronically. So "608" can play split-second differences in option prices that specialists and market-makers might not catch.
The possibility of doing so occurs on a pretty regular basis. On Wednesday,
IBM's
(IBM) - Get International Business Machines Corporation Report
January 110 calls at one point were trading with a bid/offer of 7 1/8-7 5/8 on one exchange and 7 3/4-8 1/8 on another. A quick-fingered trader would be able to buy at 7 5/8, turn around and sell at 7 3/4 risk-free.
Great idea, but don't expect great execution. "It sounds easy, but be realistic about how quickly you can get your order filled," said Paul Foster with
1010WallStreet.com
, a Web site affiliated with floor-trading firm
Mercury Trading
.
Sometimes up to five minutes can go by before the orders are executed, time enough for that disparity to disappear.
But "608," rumored to be a former market-maker on the
Pacific Exchange
, is no genius. He probably just built, or bought, software that seeks out the miniscule price anomalies, then zaps two simultaneous orders to two different floors using a program similar to the ones built by brokers such as
Preferred Trading
or
Interactive Brokers
, a unit of the large professional trading shop,
Timber Hill
.
The "608" guy, and others like him, look for either a "locked" or "crossed" market where bids are off an 1/8 or 1/4. "Do that 1/4 point 100 times a day, and that's $2,500 a day, risk-free. Can you handle that?" laughs the head of one online brokerage that's building options into its trading network.
Traditional retail brokerage firms understand how lucrative commissions from options arbitrage can be.
Charles Schwab
(SCH)
,
Fidelity
and
E*Trade
(EGRP)
, as well as options specialists like
Mr. Stock
and
Wall St. Access
, provide options trading on their sites. Others, such as
Datek Online
, plan to add options this year.
Pros Long for Linkage
The trading industry, which has resisted
linking the exchanges for decades, now finds itself in the unlikely position of almost needing to do so in order to prevent getting tripped up by traders such as "608."
"The banditry will push the industry to link up the auto-execution systems so it doesn't happen anymore," says Jon Najarian, founder of Mercury Trading. He and other Chicago floor traders picked off by "608" have railed against these so-called "RAES bandits." (RAES is the acronym for the CBOE's Retail Automatic Execution System.)
"Look at these options with stocks that move quickly and have thousands of quotes, like AOL and
Amazon.com
(AMZN) - Get Amazon.com Inc. Report
," says another option strategist. "Market-makers get buried in the heat of the day, because options are multiply listed and the traders can't keep up."
Customers may love the price war that's arisen from multiple listing, but these price disparities have floor traders seeking some respite, even if it ends up taking the form of an exchange linkage system.
Until then, however, options arbitrage is going to be worth a lot of money to "608," whoever he is.
This story was originally posted Jan. 20 at 3:30 p.m. EST.
TSC Options Forum aims to provide general securities information. Under no circumstances does the information in this column represent a recommendation to buy or sell securities.
