Is TSMC's arbitrage trading too crowded? Goldman Sachs offers a new perspective
Investors have always favored the arbitrage strategy of buying Taiwan Semiconductor's Taiwan-listed shares while shorting Taiwan Semiconductor's American Depositary Receipts (ADR). However, recently Taiwan Semiconductor's ADR has surged, causing heavy losses for arbitrageurs. Gaohe Securities suggests that investors can refrain from buying stocks and instead opt for arbitrage through derivatives. By purchasing put options on Taiwan Semiconductor's ADR while selling put options on Taiwan-listed shares, investors can achieve zero-cost arbitrage
Arbitrage using the price difference between Taiwan Semiconductor's Taiwan-listed shares and its American Depositary Receipts (ADR) - buying the underlying stock while shorting the ADR - is currently one of the most popular trades on Wall Street. However, with the continuous rise in the price of Taiwan Semiconductor's ADR, the premium between the ADR and the Taiwan-listed shares has reached 20%-25%, the highest level since 2009, leading to significant losses for arbitrageurs.
Goldman Sachs, in its latest report, suggests that investors can forego buying stocks and instead engage in arbitrage through derivatives. By purchasing put options on Taiwan Semiconductor's ADR while simultaneously selling put options on the Taiwan-listed shares, investors can achieve a zero-cost arbitrage.
Goldman recommends investors to buy 98% parity put options expiring in September and simultaneously sell put options on Taiwan stocks at parity. Alternatively, investors can also buy 97.3% parity put options expiring in September on American Depositary Receipts and sell put options on Taiwan stocks priced in US dollars.
By setting both the buying and selling strike prices at the current market price, the net input cost of the entire strategy is zero. If the ADR and Taiwan stock prices converge, the previously purchased ADR put options will appreciate, while the sold Taiwan stock put options will depreciate, thus earning the price differential profit.
Moreover, even if the stock price moves contrary to expectations, the losses are limited and the risk is manageable. The Goldman Sachs team stated:
Traders prefer this put hedging option strategy as it helps significantly limit the maximum loss risk amid the continued hype in US technology/artificial intelligence. The biggest risk in cash trading strategies is that the ADR may continue to rise with the help of artificial intelligence, potentially further expanding the premium.
With Taiwan Semiconductor's ADR price climbing 73% this year, the demand for its options contracts is also increasing. The prices of these contracts have become more expensive, with the three-month option implied volatility rising to the highest level since October 2022. At the same time, the ratio of put options to call options has also risen to the highest level in nearly two years