In this article, we’ll know more about dax aktuell and we will forever (yeah, right!) put away the argument that buying stock and buying a protective put option is somehow the SAME THING as buying a call option.
Sigh… It looks like once again I have to address this question of long calls versus married puts.
Seems that there are a few self-appointed critics out there that still fail to recognize the math behind parity, and therefore make the mistake of claiming that a married put trade and a long call trade are identical.
I’ve read a lot of blog posts about RadioActive Trading, some flattering and some less flattering… and I have to admit I’m very, VERY happy about the controversy… because even the negative stuff gets the word out more. No news is bad news, as they say.
Before even going into the argument about why I use married puts, and why they are not the same thing as call options, let’s examine this word, “IDENTICAL”. Identical means that there is NO difference at all between one thing and another.
First, I’ll say that not even “identical” twins are truly identical. Their personalities have differences, they have different fingerprints, and I’ve known several pairs of them. I can tell the difference. Even if I couldn’t tell the difference, THEY would be able to, wouldn’t they? You would never hear, for example, an argument between identical twins like this:
“I’m Tommy.”
“No, I’M Tommy, you’re Timmy!”
😉
Kidding aside, it never ceases to boggle my mind how my critics will say that long calls are IDENTICAL to married puts, and then go on to say that long calls are better because they require less capital.
Identical but better? Hmm? What’s that word mean again?
If we want to stick with the word, “identical” we’d at least better be consistent. If we say that two things are identical but one is better, that is an oxymoron. Reminds me of civil rights questions… you know, all men are created equal… but! SOME are created more “equal” than others. Doesn’t fly very well, does it? Not in real life.
Well, I promised a math lesson, not a language lesson… but one quality that those two disciplines share is logic. That’s why it doesn’t surprise me that folks that don’t pay much attention to math can’t seem to express themselves adequately with language either.
So let’s tackle the logic, now that we’ve handled the inescapable fact that the two trades are NOT (as defined by my critics’ own comments) the same in every way.
Okay, are we ready? First off, we have to do away with the word, “IDENTICAL” and instead begin to use the word, “PARITY”.
Here’s the financial definition for the word, parity, available at
http://financial-dictionary.thefreedictionary.com/parity :
1. The state of being equal… parity is achieved when the value of a convertible security equals the value of the underlying common stock.
What’s a convertible security? Why, it’s any combination of the following: cash, bonds, stock, options, et cetera… that can be exchanged for another convertible security.
For example, a call option on a certain security that’s in the money, plus a certain amount of CASH… may be exchanged for the underlying stock plus a put at the same strike. There is parity in this trade, because things equal to the same thing are equal to each other.
Let’s make a little comparison between a married put trade and a long call trade:
June 1st, 2006: March 07 $115 options. DIA trading at $112.40
Calls Puts
Bid $5.40 Ask $5.70 Bid $5.70 Ask $5.90
To buy the March 07 $115 calls, you would spend only $5.70.
OTOH, to buy a married put trade at the same strike, you would spend $112.40 + $5.90 = $118.30.
Let’s compare: at first blush, it seems that DIA calls would be a better way to go, because… well, that’s so much cheaper! After all, we only have to commit $5.70 with the long calls, and $118.30 with the married put.
But these are supposed to be PARITY plays, meaning that they bear the exact same risk and reward as a dollar amount. Right? Okay, let’s see how that works out. Fast forward to St. Patty’s day… on March 17th, DIA is now at $121.05. Both plays made a profit.
First, the long call: How much is it in the money? $121.05 – $115 = $6.05.
So we may either spend $115 plus turn in our call in exchange for 100 shares of DIA… or we may simply sell the call and count our profits. Let’s do that:
$6.05 (value of the call at expiration) – $5.70 (what we spent for said call) = $.35.
We’ve made a $.35 profit on our investment of $5.70, or 6.14%. Good deal.
Now let’s count up the married put trade: The put is worthless, and DIA is trading at $121.05. Let’s subtract that current price from the amount that we spent for the married put: $121.05 – $118.30 = $2.75
Now, tell me I’m missing something… the long call made only $.35, whereas the married put made $2.75, not to mention the dividends (DIA pays them monthly) that you would have collected for owning the stock. You would not have collected them if you’d only been holding a call option.
Hmmm. That’s a different dollar amount, isn’t it?
(here’s where you nod, YES)
..but my critics, the ones that say that buying a call at the $115 strike price is IDENTICAL to buying the stock and a put at the same strike…. will continue to maintain that they are somehow the same exact play. Of course, by now they have abandoned the word, “identical” because long calls are (supposedly) BETTER… 😉
Well, here’s the part where we find out whether they were right…or NOT… to say that these were even “parity” trades to begin with.
Here’s the deal. It’s what I keep TRYING to say, and what my critics keep sweeping under the carpet:
A long call at the $115 strike is NOT on parity with buying the stock plus a put at the same strike. It just isn’t. If that were so, the dollar amounts of profit would be exactly the same… but they aren’t.
The married put cost a total of $118.30 to put on, yes. And as a percent, it returned less but the dollar amount is much more. What WOULD make this a parity, a synthetic equivalent, an exact dollar for dollar and trade would be this tiny tweak:
AT the MOMENT that you buy the long, $115 call for $5.70… take the remaining ($118.30 – $5.70) = $112.60 and put it in an interest bearing account.
You will find that the meager profit for the long call of only $.35… will be supplemented by the interest from that deposit.
In fact, you’ll find that the interest from depositing that much capital (and not touching it) plus the $.35 profit from the long call trade will be PRETTY MUCH THE SAME as investing $118.30 in the stock plus put…. and having $2.75 in profits plus dividends.
Some folks may wish to keep repeating the mantra (as though that will make it true): calls are same as married puts… calls are same as married puts… calls are same as married puts… calls are same as married puts…
…but they are mistaken.
A married put is not equal, equivalent, parity, or IDENTICAL to a long call. No way. A married put is parity with a long call WHEN (and only when) there is a commensurate amount of capital on deposit in a risk-free interest-bearing account.
Period.
I’ll say it one last time, because it bears observance: a properly purchased married put is less risky when you’re wrong, and more profitable when you’re right… than a simple long call. Just pointing out that a call costs less does not make it better.
To make a long call be truly equivalent to a married put, one must put the SAME AMOUNT OF CAPITAL into both trades. You must buy stock and a put, or you must buy T-Bills and a call. No way around it, not if you want to have the same exact risk/reward picture.
This condition of having capital on deposit in an interest bearing account WOULD make a long call “parity”, “synthetically equivalent”, or any other word you might choose (except of course, IDENTICAL) to express the similarity between these two instruments.
You have to have capital to trade effectively… and that’s the truth. Seeking to use a call ALONE as a substitute for the capital you need to make your trading account shake and bake, just won’t work.
SO next time you read a blog post written with a superior-sounding attitude that asserts “Oh, trading married puts is JUST THE SAME THING AS trading a long call… there’s NO difference… except that calls are better…”
Well, now YOU’LL know better.
I'm Kurt Frankenberg, and I have discovered how to truly put the odds on the side on the individual investor.
I checked the historical options prices and they’re correct. However, it seems to me that the above example was due to options mispricing. Look at it this way –
Calls/Puts
Bid $5.40 Ask $5.70 Bid $5.70 Ask $5.90
Strike 15, DIA trading at 112.4.
Any market maker or investor during that time would: Buy the put, and sell the call, for a net debit of .5. You would have a synthetic short position at about $14.5. With the stock trading at $112.4, you would simply buy the stock, creating an arbitrage profit. Therefore I don’t think this is a valid example. Do you have a better example to put the point across? It appears to me the P/L on married puts vs long calls are still the same. Thanks.
p.s. if i don’t get an automatic email response, please email it to me…
Josiah, you are right. Arbitrage is at play here, and hence the (wrong) conclusion.
The long call is IDENTICAL to a Married put in a perfect market (which isn’t manipulated by those market makers :-).
Hi Josiah,
Actually, yes, it is a valid example. You can find lots of real examplesthat appear the same way.
As you pointed out the historical data are correct.
(BTW, “data” is the plural of “datum”, a word that is hardly ever used. Since the word “data” is plural, it’s grammatically correct for me to say ‘those data ARE correct’. English teacher for a mom, don’tcha know. If you ever see a grammar error in my writing, it’s likely that an editor introduced it or that I intentionally misused grammar as a figure of speech.)
Ahem. Yes, the historical data ARE correct and your observation that a market maker or investor COULD (not would… could) use this as an arbitrage opportunity is also correct.
I say “COULD” because not all mm’s and investors are interested in arbitrage. But yes, there is an application here.
The pricing differentiation that causes this phenomenon is described Black-Scholes’ equation’s inclusion of the current risk-free interest rate into options pricing.
Why does it go unexploited? Why, because the amount that one could skim by doing said arbitrage trade… would be on par with “risk-free interest” from T-bills. It’s simpler and less commission simply to buy T-bills.
Simply “put”… when you buy a stock and a put in lieu of buying a call, you actually take advantage of this arbitrage opportunity and apply its profit to your purchase.
Yup.
Buying a call is NOT synthetically equivalent to buying stock and a put and the same strike. Buying a call AND depositing a commensurate amount (of capital that would normally be used to buy the stock) into an interest bearing account is the synthetic equivalent of buying stock and a put.
Whew. Get all that?
Now, here’s why that is significant, in two easy lessons:
First, you get to exploit the arb opportunity to which you’re referring and therefore get a lower price for your net purchase of the stock and put. Your projected income from interest is “pre-paid” in the form of a lower net price on the net position, up front.
Second, you are forced NOT to misuse the capital that you would have left over, had you simply bought a call.
While this is the place where most ‘options experts’ stop me and say, “well… of course I would deposit that capital and get the interest.”
Then that’s where where I stop and say, “You’ll be the first one that I’ve heard of that actually DOES.”
Everyone that brings up the equivalency issue points out to me that the best thing about trading a long call in favor of a married put is THAT THEY COULD USE THAT CAPITAL FOR SOMETHING ELSE. Here are some ways folks misuse that capital, listed from best worst:
1) failing to deposit the capital in an interest bearing account
2) playing some of the capital in the form of OTHER long calls on OTHER stocks
3) buying more than one call for each block of capital that should have been used to buy a married put
TO wrap it up Josiah… buying a long call is NOT the equivalent of a married put. Money management is not built in, you risk a little more money, and it’s easy to get confused about what you have.
Buying a long call is one way to play a bullish expectation, and a married put is very close to the same thing. But with a married put I have a lot of things clearer and easier to manage.
Happy Trading!
Hey, maybe I should also have included this point, since I already have elsewhere:
There is also the matter of trading clearance for the so-called “Income Methods.”
The Income Methods are simply adjustments to a position, and they are almost always done at a credit.
Thing is, some folk’s trading clearance WON’T permit them to do these adjustments against a long call. However, there is no problem doing most of the adjustments against a married put.
For example, let’s say you have a few hundred thousand in a Scottrade account. They don’t even allow spread trading. In the case of the married put, if you wanted to do Income Method #6: Selling a Bear Call Spread to take some income now while leaving the potential upside of your net position unlimited… you’d be out of luck with a long call. They won’t even LET you sell calls against calls.
On the other hand, if you own a married put… you may sell a covered call against the stock, and purchase a call at a higher strike. This adjustment is “synthetically equivalent” to selling a bear call spread against a long call. But you can do it with a much lower clearance or with an over-stringent broker.
Happy Trading!
To me, it makes more sense to say Long Call is same(almost) as Married Put under two cases:
1. When the expiration is reached
2. Options get deep in the money.
Before expiration, they deviate by a big margin. Here’s a simple example using QQQQ
Scenario (April 1st, 2010): Set up a collar trade. i.e, Buy 100 stocks of QQQQ @ $50.50+ Buy May 10 $50 Put @ $1 + Write May 10 $51 Call @ $1
Synthetic equivaluent of this would be: Buy May 10 $50 Call @ $1.5 + Write May 10 $51 Call @ $1. This is a bull call spread.
Assuming there’s 30 days prior to expiration, here’s some cases to look at:
On Day 2, QQQQ rose to $51:
Net profit for collar set up is approximately: 50 cents.
Net profit for bull call spread is approximately: 20 cents
But let’s say the stock has risen to $60 instead(options deep in the money):
Net profit from both collar and spread would be 50 cents.
If QQQQ is at $51 at the end of May expiration, the net profit would be 50 cents.
Any thoughts??
The example you provide to support your argument involved longer dated options (288 days to expiration) in a market environment where treasury yields were close to 5% and the underlying ETF paid monthly dividends. In this instance, there are some inherent advantages of the married put over the long call and I completely agree that the married put is the superior strategy to the long call (assuming the extra capital is not invested at 5% for the life of option.)
However, in today’s interest rate environment, there is little to no difference between the married put and the long call when trading shorter dated options where the underlying does not pay a dividend.
Example using last month’s prices in AAPL
Mar 19, 2010
AAPL closes at $222.25
Apr 220 Call (bid $7.75, ask $7.85)
Apr 220 Put (bid $5.50, ask $5.60)
Married Put – Buy 100 shares AAPL at $222.25, buy 1 Apr 220 Put at $5.60. Total cost $227.85
Long Call – Buy 1 Apr 220 Call at $7.85.
Apr 16, 2010
AAPL closes at $247.40
Married Put P/L: $247.40 – $227.85 = $19.55 profit
Long Call P/L: $247.40 – $220 – $7.85 = $19.55 profit
Same exact P/L without having to invest the saved capital of $22,000. Fewer commissions on the long call vs. the married put actually makes the long call appear to be the better strategy.
Example using last month’s prices in GILD
Mar 19, 2010
GILD closes at $47.87
Apr 48 Call (bid $1.04, ask $1.07)
Apr 48 Put (bid $1.16, ask $1.19)
Married Put – Buy 100 shares GILD at $47.87, buy 1 Apr 48 Put at $1.19. Total cost $49.06
Long Call – Buy 1 Apr 48 Call at $1.07
Apr 16, 2010
GILD closes at $45.70
Married Put P/L: $48.00 – $49.06 = -$1.06 loss
Long Call P/L: -$1.07 loss
Essentially the same exact P/L (difference of $1.00 on 100 shares) without having to invest the saved capital of $4799. Taking commissions into consideration, again the long call appears to be the superior strategy.
So to answer the question, “which is better the long call or the married put?”, in my humble opinion the answer should be “it depends.” It depends on the length of the trade, the risk free interest rate and whether or not the underlying will pay a dividend over the duration of the trade.
I do not profess to be an options expert so I welcome any comments that you may have to refute my argument.
Hi Jerry!
The question, “Which is better, the long call, or the married put” was NOT the premise of my argument.
The premise was that married puts and long calls are not identical, or even parity trades, though they have a similar risk/reward curve.
You have brought to the table a point that I WISH more folks would entertain: “Which is better? It DEPENDS.”
This is a point that I have zero problem with. I have to concede that there are times that a long call might be better, provided of course you are using proper position sizing… which the married put trade makes automatic… but yes, it DOES “depend”.
We’ve come to a place of understanding that married puts and long calls are not identical… thank goodness… but depending on market conditions which to choose? Depends.
On what does it depend? Not only upon interest rates, as you seem to have implied. Yes, I did use an example from 2006, when interest rates are different from today. However the new interest environment does not make the 2006 example invalid. Let’s use one from TODAY, May 20, 2010:
CREE is at $65.85…
The January 2011 $80n calls are trading at $15.05 X $15.60. It’s likely that you could get filled in between the spread, so let’s say that means a $15.40 investment for a long call.
On the other hand, the January 2011 $80 puts are trading at $27.75 X $28.35.
Let’s say that you can’t get filled in the spread… even if you couldn’t, the investment for a married put would be $28.35 for the put and $65.85 for the stock.
Of the two investments, which can lose more percent-wise? Certainly we are talking about the long call, because 100% of it is AT RISK. The percent of the total investment in the married put trade, however, is only 15% AT RISK.
Well, what about the actual dollar amounts? The long call trade risks $15.40, assuming that we can buy it in the bid-ask spread… but the AT RISK amount for the married put position is $14.20. Check my numbers above, stock price ~ plus put price ~ minus put strike. This yields the AT RISK dollar amount.
You can account for this with interest rates but it also has something to do with the put/call ratio. On this very day, the CREE Jan 2011 $80 long call is inferior to the CREE Jan 2011 $80 married put in terms of percent and actual dollar amount risked.
See that? I think I’ve done a lot to logically and truthfully demonstrate that given the same market sentiment, there are many reasons one might prefer a married put over a long call because they are not IDENTICAL. However, it is true that there are times that the pricing swings the other way. Check out this other, current example:
May 20, 2010 CTRP at $36.00…
The Jan 2011 $45 calls are priced at $3.60 X $3.80. On the other hand, the $45 puts are at $12.30 X $12.90.
While I COULD make the argument that there’s a lot more spread to work with in the puts than in the calls… I won’t. Let’s just use the ask prices.
Buying a long call would risk $3.80. Buying a married put at the same price would risk $36 (stock) + $12.90 (cost of put) – $45 (strike of put) = $3.90.
SO in this case buying a long call would risk ten cents less than buying a married put at the same strike.
Now, add to this proper position sizing… say, having the discipline to ACTUALLY put on deposit the amount that it would take to purchase the stock in the first place, and I would have to say that in this case the long call purchase makes more sense.
Point is, you are right… which is better? It DEPENDS. But it does NOT depend upon what year we are trading and what the interest rates are especially. There is more here than meets the eye. I’m just SO GLAD that someone is seeing the difference rather than repeating the mantra of “call equals married put, call equals married put…”
😉
Keep up the good thinking Jerry! I look forward to your next post. IN the meantime, check out what married puts and forced position sizing have meant to my actual account… still UP even though I pick losers more often than winners 🙂
Happy Trading,
Kurt
I question the pricing for the CREE example. Assuming mid prices, I could have gotten synthetically short for $67.27 ($80.00-$28.05+$15.32) with the stock trading at $65.85. That’s a difference of $1.42.
Even using the natural as worst case, I could have gotten synthetically short for $66.71 ($80-$28.35+$15.06) which would be a difference of $.86.
I would be surprised if the synthetic was really trading that far above the stock. If it was, it probably wasn’t for very long.
Regards,
Jerry
Dude… seriously, I do these kinds of trades ALL the time. You may question the pricing, but it’s how it is.
When I get into a stock plus put combination, I get filled at the ask sometimes but almost always between the strikes… and with “edge” like I’ve described.
You’re welcome to follow along with me!
Happy Trading,
Kurt
Kurt,
I’m assuming you are familiar with put/call parity and options pricing models since you like to talk about how a long call is not equivalent to a married put. Therefore, I’m surprised that you didn’t acknowledge the disparity in CREE pricing between the synthetic stock and the actual stock that I pointed out using the CREE prices provided in your example.
Using the mid prices of the $80 call and $80 put, the synthetic is priced at $67.27 with the stock at $65.85. The options are pricing the synthetic stock $1.42 higher than the actual. This is about $1.12 too high. The Jan2011 synthetic should only be about $.30 higher than the actual stock price.
Unfortunately, the trading platform that I use does not provide me with intraday option prices so I cannot verify the CREE pricing in your example. However, I can use end of day data to support my argument that the synthetic stock is way overpriced based on the pricing in your example.
Here are the end of day synthetic stock prices based on the mid prices of the call and put from 5/20/10 using various strikes in the Jan2011 option chain.
CREE closes at 65.01
45 Strike – Synthetic priced at $65.23
50 Strike – Synthetic priced at $65.27
55 Strike – Synthetic priced at $65.33
60 Strike – Synthetic priced at $65.30
65 Strike – Synthetic priced at $65.25
70 Strike – Synthetic priced at $65.32
75 Strike – Synthetic priced at $65.32
80 Strike – Synthetic priced at $65.35
85 Strike – Synthetic priced at $65.37
90 Strike – Synthetic priced at $65.37
95 Strike – Synthetic priced at $65.37
100 Strike – Synthetic priced at $65.33
All of these synthetics are priced at $65.30 +/- $.07 with the stock at $65.01. This implies that the Jan2011 synthetics should trade at about $.30 above the actual stock price. This is one of the reasons why I’m questioning the pricing provided in your CREE example that shows the synthetic trading at $1.42 over the stock. I’m not saying it isn’t possible but I’d be very surprised if it did.
In addition, the option pricing you provided shows a large disparity in implied volatility between calls and puts with CREE at $65.85. A mid price of $15.32 on the 80 call implies a volatility of 92.83. A mid price of $28.05 on the 80 put implies a volatility of 87.87. This intraday 5 point skew seems very unlikely when compared to the end of day pricing. At the end of the day on 5/20/10, the 80 call price implies a volatility of 62.03 while the 80 put price implies a volatility of 62.07. There was no skew at the end of the day.
Finally, when comparing the CREE options prices you provided against end of day pricing on 5/20/10, it would appear that implied volatility for the Jan2011 options went down 25-30% during the day since your pricing implies a volatility of 87-92% while the end of day pricing implies a volatility of 62%. This would seem almost impossible given the overall market conditions and the price action of CREE on 5/20/10. Virtually every measure of overall market volatility closed at or near the high on 5/20/10. In addition, CREE was down over 8.8% from the previous close, 5.5% intraday and it closed on its lows. That is hardly the environment where I would expect to see implied volatility contract 25-30% as the CREE options pricing suggests.
Everything I know about theoretical options pricing tells me that the stock/options prices you used in your CREE example should not have existed simultaneously. However, given the current market conditions of the past week, I guess anything is possible.
Regards,
Jerry
I have a hard time taking this example seriously when you argue that the two are not the same by saying the profit amounts are different. A better argument would be comparing the % returns. Of course you aren’t going to make as much profit when you put up less than 5% of the capital in the long call scenario. I think thats a given. Theorectically in a vacuum the two trading strategies are the same, but, just as with the covered call vs. naked put, mechanical differences can arise.
Hi Joel,
Well, here’s the deal. I had a guy ‘challenge’ me to a ‘duel’. He didn’t get into the same issues that I did so we weren’t comparing apples with apples. But here was the outcome: Using $5K and options only, he made $1K during a period of time in which I was trading $100K and made $2K.
He declared himself the winner, because after all he had made 20% and I had made 2% in the same six week period. But there’s a flaw in that logic, isn’t there? Using my “Forced Position Size” principles, I never had over 5% (or $5K) of my total capital AT RISK. He had 100% of his $5K AT RISK.
So essentially we were risking the exact same amounts. 100% of $5K is exactly equal to 5% of $100K. And, risking the same amount, I did twice as well. I generated just over $2K while he made $1K.
What if my stocks… and his… had gone down in the same timeframe? Say I lost my entire AT RISK amount, around 5%? If the market treated him as poorly, he would have lost it ALL.
Joel, I have to say that position sizing is not only important… it’s the MOST important thing. And regarding the performance of my portfolio in that timeframe, ‘apples to apples’ would have been if my self-proclaimed opponent had actually had $100K on deposit in an interest bearing account and only touched 5% of it for trading long calls.
2.75 / 118.30 is only 2.3%
Kurt;
What if one is Bearish on a particular instrument. Is the flip side true ? Sell the stock and buy a call?
Hi Matthew! Although that can be done, due to some margin charges for shorting stock and other restrictions, we have other ways to approach the limited risk technique in a Bearish market. Blueprint Owners and Fusion subscribers have access to a Members Only webinar – Playing the Bear Side of the Market.
Alternatives for the ‘Married Call’ approach in a bearish market might include:
Trading a RadioActive Position on an inverse ETF (don’t have to think backwards ;))
Buying a Put, and leaving cash aside to have only single digit risk, but profiting downside
Restructuring the existing RadioActive trade to profit in either direction, or just to the downside.
I hope that helps, and sorry for the delay in the comment!