tactical trader

Professional market maker Joe Kinahan introduces some of the tricks of the trade that allow you to profit from options trading by looking at your positions in the same way as the pros.

Options trading is often a difficult and complex process. However, there are ways to take the mystery and confusion out of even the biggest and most complex positions. One of the most useful tools that any options trader can have is a thorough knowledge of equivalent options positions. This knowledge will benefit you again and again as you look at different trading scenarios and positions.

All Synthetic trading comes down to the most basic of option equations:

underlying price = strike price + call price – put price

From this equation we are easily able to see how we can create profit opportunities by keeping ourselves open to the idea of substituting one option for another. The rest is similar to basic algebra. We know that:

underlying price = strike price + call price – put price

So:

call price = put price + underlying price – strike price

And:

put price = call price – underlying price + strike price

This then leads to the synthetic equations that make options interchangeable in that:

long call  + short put        = long underlying

short call + long put         = short underlying

long put   + long underlying  = long call

short put  + short underlying = short call  

short call + long underlying  = short put  

long call  + short underlying = long put

These examples are assuming no commissions (as they vary widely) and no interest costs. Many of you will recognise that this is the basic premise behind conversions and reversals, as we are not taking interest rates and dividends into account we will not pursue those any further in this article, but that is the next logical step from synthetics.

Now that we have reviewed the very basics let us take things one step further and use real-life examples so that we can apply these equations to the markets that you are trading and help this review to become ingrained knowledge…