SteadyOptions is an options trading forum where you can find solutions from top options traders. Join Us!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Option Equivalence


Some option positions are equivalent – that means identical profit/loss profiles – to others. Others are not. A few days ago I had an inquiry from a person trading options in a restricted account (e.g. an IRA that did not allow marginable trades or short options positions):

I have an IRA in which I trade options.  I wanted to sell a put, but my broker won’t allow the sale of puts in my account.  Isn’t it true that opposite option positions are equivalent?  In other words, instead of selling a put at strike X, couldn’t I just buy the call at Strike X and get the exact same risk and/or return?”

 

I was quite taken aback by the question, but after digging around, I learned that many investors believe opposite option positions are equivalent.  This is not true.  Rather, equivalent option positions can be found through one simple equation:

 

S = C – P

 

Where S is the stock, C is a call at strike X and P is a put at strike X.  In other words, the following two positions are equivalent:

 

  1. Sell 5 contracts of the March 31 100 puts on stock ABC; AND Buy 500 shares of ABC
  2. Sell 5 contracts of the March 31 100 call.

 

This position is called a “synthetic stock” position, which can be constructed by going long a call and short a put at the same strike. 

 

A trader can rearrange the above equation and get:

 

C = S + P (also known as a “married put”)

 

Or

 

P = C – S

 

These three differing positions should perform the same with the same returns.  Of course, in reality that is not what occurs for a variety of reasons:

 

A.  Commission Costs

 

An investor pays X commission to purchase stocks (e.g. $7.99/trade).  The same investor pays X+ to purchase options. (Buying options is typically more expensive, although commissions vary for different products.) Buying a single side of the equation likely will reduce the cost of the trade, thereby changing the performance of the overall trade. 

 

Any experience option trader knows that commissions eat more into gains than any other single factor (other than making horrible trades). 

 

B.  Bid/Ask Spreads

 

Every option has a bid/ask spread.  On highly traded instruments, this might be a penny or two.  On less liquid options, there may be a spread of a few dollars.  On the other hand, with stocks, the bid/ask spread is almost always smaller than the bid/ask spread on the options on the same instrument.  This means constructing a synthetic stock position will almost always cost more than simply buying the stock.

 

Of course, a synthetic stock position also gives an investor the opportunity for leverage, not available with just going long on a stock.  Investors are encouraged to work through the risk/reward of using leveraged through synthetic stock rather than simply buying the stock for a lower total cost.  Depending on each trader’s goals, risk tolerances, and the specific trade, leverage through synthetic options may be a better trade setup – or it may not.

 

C. Exiting Before Expiration

 

Options stop trading the Friday of their expiration at the market close.  But the underlying stocks typically continue to trade in the after-hours markets.  (This is known as expiration risk).  Because of this, on the day of expiration, option positions that are at the money or only slightly out of the money maintain a premium on the positions.  In other words, if an option position is only slightly out of the money on the day of expiration, the position won’t close for $0.00, even though the above equation suggests that it should be able to do so.  A trader likely would have to pay (or receive depending on the position)at least a nickel to exit the position. 

 

This slippage also results in the positions not being exactly equivalent – despite theory and math suggesting they should.

 

Option traders should be well aware of the basic equations with equivalences.  There are times, due to inefficiencies in option pricing from volume/demand/market maker errors, when entering an equivalent position may result in more profit.

 

At other times, knowing the equivalent positions will allow investors to enter into trades in restricted accounts that they may not otherwise have been able to enter.  Still in other situations, depending on an investor’s margin requirements, entering into an equivalent position may save margin interest – or free up cash to enter into more trades (e.g. leverage).

 

To experienced option traders, the above is blindingly obvious.  If an investor does not understand option equivalence, it might be best to take a step back and study more, trade on paper, and learn more before putting capital at risk.

 

Christopher Welsh is a licensed investment advisor and president of LorintineCapital, LP. He provides investment advice to clients all over the United States and around the world. Christopher has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™. Working with a CFP® professional represents the highest standard of financial planning advice. Christopher has a J.D. from the SMU Dedman School of Law, a Bachelor of Science in Computer Science, and a Bachelor of Science in Economics. Christopher is a regular contributor to the Steady Options Anchor Strategy and Lorintine CapitalBlog.

 

What Is SteadyOptions?

12 Years CAGR of 115.5%

Full Trading Plan

Complete Portfolio Approach

Real-time trade sharing: entry, exit, and adjustments

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Subscribe to SteadyOptions now and experience the full power of options trading!
Subscribe

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • When Investors Lose Their Nerve

    It was a rough end to the week for markets, with a sharp sell-off on Friday reminding investors just how quickly sentiment can turn. For anyone who sold in late summer anticipating a correction and then bought back in at the start of October, that one-day drop might have felt like confirmation that they can’t win.

    By Kim,

    • 0 comments
    • 255 views
  • Uncovering Common Cryptocurrency Trading Mistakes For Beginners

    Are you tempted by the shining allure of crypto trading? You aren’t alone. Decentralized cryptocurrencies hold perhaps the most tempting investment pull of a generation, especially amongst young or beginner investors. After all, by painting a different way to buy and sell, cryptocurrency offers something new that we’re all keen to get in on. 

    By Kim,

    • 0 comments
    • 6916 views
  • Buy Call, Sell Put Strategy Explained | SteadyOptions

    The Sell Put And Buy Call Strategy is an example of a synthetic stock options strategy: using call and puts options to mimic the performance of a position, usually involving the purchase of a stock. We saw this when looking at the synthetic covered call strategy elsewhere.

    By Chris Young,

    • 0 comments
    • 67288 views
  • Long Straddle Options Strategy | Maximize Profits with Big Moves

    Straddle Options Definition
    An options straddle strategy is buying (or selling) both a put and call option with the same strike price and expiration date for the same underlying asset, and paying both the put and call premiums.

    By Pat Crawley,

    • 0 comments
    • 67780 views
  • Gamma Scalping Options Trading Strategy

    Gamma scalping is a sophisticated options trading strategy primarily employed by institutions and hedge funds for managing portfolio risk and large positions in equities and futures. As a complex technique, it is particularly suitable for experienced traders seeking to capitalize on market movements, whether up or down, as they occur in real-time.

    By Chris Young,

    • 0 comments
    • 30615 views
  • Long Gamma vs Short Gamma: Options Strategy Explained

    Gamma is one of the primary Options Greeks, which measure an option's sensitivity to specific factors that could affect an option price. Despite traders hyping up several different Greeks and second-order Greeks like "Vanna" and "charm," there are only four primary Greeks that you need to be familiar with to understand options trading.

     

    By Pat Crawley,

    • 0 comments
    • 50136 views
  • Predicting Probabilities in Options Trading: A Deep Dive into Advanced Methods

    In options trading, the focus should not be on predicting the exact closing price of a ticker on a given date - a near-impossible task given the pseudo-random nature of markets. Instead, we aim to estimate probabilities: the likelihood of a ticker being above a specific value at a certain point in time. This perspective turns trading into a probabilistic exercise, leveraging historical data to make informed decisions.

    By Romuald,

    • 1 comment
    • 16985 views
  • SteadyOptions 2024 - Year in Review

    2024 marks our 13th year as a public trading service. We closed 136 winners out of 187 trades (72.7% winning ratio). Our model portfolio produced 116.7% compounded gain on the whole account based on 10% allocation per trade. We had only one losing month (of 0.6% loss) in 2024. 

    By Kim,

    • 0 comments
    • 6481 views
  • Wheel Strategy Options: Master Wheel Trading Explained

    The “wheel” trade is variously described as a beginner’s strategy, a combination to exploit features of both calls and puts, and as “perfect” solution to the well-known risks of shorting calls, even when covered. The options wheel strategy is an income-generating options trading strategy that both beginners and experienced traders can leverage for profit.

    By Pat Crawley,

    • 0 comments
    • 76080 views
  • Why Dollar Delta Will Change Your Trading

    Delta is one of the four main option Greeks, and any serious trader needs to have a thorough understanding of this greek if they hope to have any chance of success in the trading options. If you’re a beginner, you can visit my blog to learn more about understanding option delta

    By GavinMcMaster,

    • 0 comments
    • 36605 views

  Report Article


We want to hear from you!


There are no comments to display.



Join the conversation

You can post now and register later. If you have an account, sign in now to post with your account.
Note: Your post will require moderator approval before it will be visible.

Guest
Add a comment...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...

Options Trading Blogs