The following is a post by Christopher Ebert, who uses his engineering background to mix and match options as a means of preserving portfolio wealth while outpacing inflation. He studies options daily, trades options almost exclusively, and enjoys sharing his experiences with anyone who is interested.
Many stock traders avoid the options market, often due to a perception of risk. But the real risk lies in not learning how options can work to enhance returns. Options themselves are not complicated; they are simple contracts available to almost any trader upon completion of a short approval process with a broker. What a trader may not realize is that every single stock trade involves taking on the equivalent of an option position; and that position may not always be the best choice among all options available.
It should make sense then, for a successful stock trader to compare option positions before opening a stock trade. Every option position has a component of time value based upon the amount of risk involved and the potential reward. A long call at-the-money, for example, has a relatively high amount of time value while a deep in-the-money call has much less. In addition, some combinations of options, such as a synthetic long (long call and a naked put at the same strike price) have zero time value.
Purchasing shares of any stock is essentially the same as opening a synthetic long option position. The position has no net time component, and therefore provides no downside protection while presenting no restriction to upside movement. Options can be confusing, so that statement bears repeating: Buying 100 shares of stock is the same as buying 1 call and selling 1 naked put at the same strike price. There are conditions when either the stock or option position is justified; and because the synthetic position requires only margin maintenance and no significant capital outlay, it may be actually be preferable.
The intent here is not to recommend any stock or synthetic stock positions, but rather to suggest that those interested in learning how to trade options begin by taking a new look at their own stock trades as if they were composed of options.
- Someone intent on buying 100 shares of Apple (AAPL) at $427 would need over $42,000 in capital outlay.
- A synthetic long position at the Feb. $425 strike would only require approximately $230 (if margin requirements were met).
- An alternative might be a long call at the Feb. $350 strike, with a total premium of about $7,800.
All 3 positions would have nearly identical short term performance, given that delta is very close to 1 on each. However, each has its disadvantages. The long stock requires a large amount of capital, the synthetic stock requires margin and also is subject to a small amount of slippage due to the bid/ask spread, while the long call would lose an average of $3 per day through time decay. One suggestion for the potential option trader would be to continue trading stocks as usual, but also paper trade options along side of them.