Alexander Valtsev
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Earn A Riskless Return On An Arbitrage Strategy With SolarCity

SolarCity's (SCTY) shares have increased dramatically since my last analysis on the company:

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 future because I have identified yet another arbitrage strategy with the stock and its options:

(Source: Google Finance)

Note: the above table shows prices for SolarCity's options expiring on January 20, 2017.

The biggest concern with the arbitrage strategy I am talking about is liquidity. As you can see in the table above, there is not much volume in option even with such a close expiration. Nevertheless, small volumes (up to 10 - 20 contracts) will likely get filled by market makers. So, here is what I propose:

(Source: market data)

Note: I used bid prices for the options being sold and ask prices for the options being bought for calculations.

In essence, I am offering you the same deal another WhoTrades contributor talked more than a month ago with reference to SunEdison: buy the synthetic long and sell the stock short. This transaction results in an immediate credit balance of $30.32 per share and simultaneously locks in a profit of $2.90 per share:

(Source: author's calculations)

In order to prove to you that this strategy delivers the same profit at any price of the underlying, I modeled outcomes of the stock price ranging from $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 you a strategy that will generate you a 6.4% return (assuming you need a 150% margin on shorted stocks, like in the case of my broker) through January 20, 2017 with virtually no risk (other than the counterparty risk). The annualized return is approximately 8.5% (calculated by dividing the credit balance received from the trade by the total margin amount of the trade).

The biggest concern with this trade 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, which may be high due to the long duration of the trade.

What do you think of this trade?

P.S. Let me know if you want to see the spreadsheet - write in the comments section.