Dan Passarelli, CEO - Market Taker Mentoring

When you're first learning options, or if you took some finance classes in college, you probably learned about this thing called arbitrage. The formal definition for arbitrage is a risk-less profit. And that is something that economists will tell you should never be possible to exist. It shouldn't be possible.

It isn't possible. But guess what? It actually is possible. I'm going to show you an example of it that I found when I was trading just the other day. So look at the screenshot that I took when I identified this situation.

This was an AMC stock. These were the four day options at the time. It was a couple of weeks ago. And if you look here, these calls, the June 17th, 40 calls were offered at two cent and the 41 calls were bid at $0.02. So there's a couple of really important and interesting things here and a couple of caveats. 

First of all, if I am able to buy the 40 calls at two cent and sell the 41 calls at $0.02, that is owning a debit spread. Owning something that can have value, can have a value of up to a dollar for those of you who are familiar with spreads and paying zero for it. So if I'm able to put that on, if it doesn't cost me anything, it can only lead to a profit, right? So that is, indeed, an arbitrage opportunity. I'll either make zero or I'll make something up to $1.

Now, here's the caveats. First of all, a glaring caveat is that there's only one contract on the bid here, right? So I would have to be quick. I certainly couldn't put in a spread to pay zero because the market makers would obviously see that and say, no, I'm not doing that. You wouldn't trade it.

So you'd have to buy, because you can only sell one of these at $0.02, when you're legging, you'd have to buy one of these at two cent and be really quick and immediately sell one of these at $0.02. Alright? So if you can do that, then you would own the spread for free. But there's another little problem with that.

Most brokerage platforms charge you some form of commissions, but some don't. The ones that charge you commissions, even though it doesn't cost you anything by the options, it costs you something to transact that purchase. If you have a platform like Robin Hood, for example, you could literally put on this trade and look, this trade was really far out of the money, like 300% out of the money or something, right? And pretty unlikely to happen. But if you could make trades like this every single day, and especially if you do more than one lot, if you could just put on like three ten lot trades like this every single day, there's going to be some days when they hit and you will have a business where you have no risk and only profit.

Now, these situations are rare. You don't come across them every time. But I wanted to point out that these indeed are real scenarios and the really savvy traders out there can identify them and can trade them. I hope that helps.