Alexander Valtsev
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Options Arbitrage Strategy With Valeant Pharmaceuticals

My newest arbitrage idea involves Valeant Pharmaceuticals (VRX). I wrote more about this trade idea on Seeking Alpha yesterday. You can see the article here. The strategy I am offering today is essentially the same as in the case of SolarCity (SCTY), which I covered last week. Basically, I found out that there was a pricing difference between the stock and its synthetic options alternative. I recommended that readers bought the synthetic and shorted the stock. Unfortunately, not a lot of people were able to do that as it was either difficult to find shares to short, or the interest on the shorted shares was so high that it eroded profits from the arbitrage strategy.

Since yesterday, Valeant Pharmaceuticals's shares have gained significantly in price, and the strategy I talked about on Seeking Alpha is not applicable anymore. Nevertheless, I managed to find another arbitrage opportunity with May options on this stock:

(Source: Google Finance)

Note: The above table shows prices for options expiring on May 6, 2016. I used “last” prices to obtain figures for calculations. The actual transaction prices at which readers may execute the strategy may differ from broker to broker.

The algorithm is the following: sell at-the-money puts (strike of $28.5), buy at-the-money calls (strike $28.50), and sell the stock short (the market price at the time of writing was $28.75):

(Source: author's calculations)

As a result of this trade, investors get the cash upfront (selling the stock is the biggest cash inflow in this trade). I hope that readers will not face problems selling Valeant’s stock short, especially given the fact that it is rallying today (hence, you can sell on the uptick).

Here is the profit/loss profile of this trade:

(Source: author’s calculations)

As readers can see, investors lock a profit of $1.05 (assuming you get the same prices as the last trader did) per contract (100 shares of stock). The optimal trade size, given transaction fees and taxes, is 5 options contracts (500 shares of stock). In terms of profitability, this arbitrage trade yields a ~2.4% return over a five-week period (a ~14% annualized return), fees and taxes excluded. The strategy is delta-neutral at initiation and remains so throughout its life, so investors will not have to worry about any rebalancing.