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Let's hypothetically say that a stock is trading at $153, and I can buy its $150 call option for $3.

If I shorted 100 shares of the stock and bought 100 options, then I would be guaranteed to break even (let's just assume $0 commissions). If the stock went up $5, I'd gain $500 on the options and lose $500 on the short sell. If if went down $3, the options would expire worthless (loss of $300) but I'd gain $300 on the short sell. And so on.

However, it seems like the option would be mispriced, because there of course is some chance that the stock will rise in value (while its $3 price implies there is no time value component to it).

If this were the case, is there a strategy that would cap my loss at $0 (as above) but give me some upside if the stock were to increase in price?

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    Note that with the strategy you describe, your profit comes if the stock falls more than $3. If it falls $10, you gain $1000 on the short sell, paying for the $300 of options and leaving $700 of profit. – Nate Eldredge Mar 5 '15 at 18:35
  • Ah, that was really stupid of me not to realize. Thanks! So I guess the inverse (make money if the stock goes up but guarantee no loss if it goes down) is to buy out of the money puts (or maybe writing calls?) and going long the stock... – Jer Mar 5 '15 at 18:38
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    By shorting the stock and buying a Call, you have created a synthetic Put. A Box spread locks P/L. – Optionparty Mar 6 '15 at 3:48
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The strategy looks good on paper but in reality, the 150 call will have some time value particularly if it has got some time to mature. Let us say this time value is 0.50 , so the call costs 3.50.

If the stock stays above 150 (actually above 149.50) , by the expiration of the call, you will lose this 0.50 . Then you need to keep buying calls over and over and hope one day a big down move will more than make up for all this lost premium.

It is possible, but not entirely predictable. You may get lucky, but it may take many months to produce a significant move to make up for all the lost premium. If a big down move were to happen and the market had any indication of that in advance, that would be priced into the call already, so the 150 call may cost 4$ or 4.50$ if the market had wind of a big move. (a.k.a high implied volatility)

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Yes, one such strategy is dividend arbitrage using stock and in the money options. You have to find out which option is the most mispriced before the ex-dividend date.

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If we ignore the extrinsic value of the 150 strike (for convenience purposes), the transaction as you suggested has no potential for upside gain Although you would hit an out of the park home run if the stock were to crash as you are now synthetically long a 150 put.

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