Question

Discuss the effect of leverage and margin requirements on the arbitrage strategy.

The Federal Reserve’s Regulation T. requires that investors post minimum initial capital of 50% for any long position and short positions. Both the NYSE and NASD require maintenance margin of 25% for long positions and 30% for short positions.

Answer 1

Arbitrage is exploiting the difference in prices of the same stock on two exchanges due to system inefficiencies at the same time. This benefit can be taken by buying and selling the same stock or derivative simultaneously.
leveraging is a facility which allows an investor to profit from risking only a specific percentage of the total amount of investment. for example say if share of company AX is of 10 £ and you wish to buy 100 shares total amount needed to be invested is 10*100=1000 £. In case of leverage only 20% of the total amount would be required to be invested ie only 200£ instead of 1000£.  

Simultaneously the profit of the investor when the stock price increase would be more in derivatives market using leverage (investment of 200 €) than in money market (investment of €1,000). Leveraging is a phenomena of derivatives market.

Margin requirement is safety margin
which Stock Exchange mandates and investor to maintain in his trading account. if invested defaults in honouring the obligation of the long and short position taken by him, then stock exchange compensates for the loss through margin money.

In the above case suppose an option is available at

Put spot price -110

Call spot price - 100

Margin to be maintained if 1 qty of put and call is bought:

Put position - 30% of 110 = 33

Call position - 25% of 100 = 25

In an assumed scenario where company announces dividends put strike price would increase and call strike price will decrease simultaneously. This is an arbitrage opportunity wherein an investor can buy call and sell put option at the same time to benefit.