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Strategies & Market Trends : Option Spreads, Credit my Debit

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To: Tim O. who wrote (1851)	12/7/2000 12:12:31 PM
From: KFE	Read Replies (5) of 2317

Tim, I'm bullish on AMKR and I want to do some synthetic 2003 LEAPs, but the ATM calls are much pricier than the ATM puts. Do you have any general suggestions on how to take advantage of options prices that are not at put-call parity Actually the ATM 03 LEAPS are priced at just about the right prices. The put-call parity relationship is related to synthetic trading. The most important things a professional options trader has to learn is to know synthetics and conversions/reversals. Call price= underlying price+put price-exercise price. Put price= call price-underlying price+exercise price. Underlying price= call price-put price+exercise price. Conversion=long underlying, short call and long put. Reversal= short underlying, long call and short put. Examining the prices of the AMKR 03 LEAPS you may think that the put/call parity is out of alignment. However, when dealing with LEAPS the cost to carry the equivalent hedge can be substantial and this is why you will see ATM puts trade for less than ATM calls. AMKR= 15.75 03 15CAll= 7.50 03 15Put= 5.125 You could buy the calls outright or buy the synthetic call (long underlying and long put)and have a lower break even point 22.50 vs. 20.875. It may appear that the synthetic is cheaper but the risk free cost of the capital invested has not been factored in yet. Buying the LEAP would require $7.50 to be invested and the synthetic buy would require an investment of $20.875. If the difference (13.375) was invested at the current risk free interest rate it would yield almost exactly the differential between the LEAP call and the synthetic call. A conversion in the LEAP would also appear to lock in a profit. Buy underlying, sell call, buy put 15.75 - 7.50 + 5.125 You would be buying the conversion for $13.375 and guaranteed to get $15. The difference $1.625 is equivalent to what you could earn risk free on the capital invested (13.375). You can see that when taking into account the cost to carry the position the LEAPS seem fairly priced. Trading synthetics and conversions and reversals are an important way market makers and professional floor traders make their profits and reduce their risk. If calls are overvalued relative to puts an options market maker will exploit this by selling the calls and buying the underpriced synthetic equivalent. Just the opposite if puts are overpriced. Generally the calls will be overpriced in a rising market and puts in a falling market. The markets are very efficient and any price discrepancy will be small and short lived. This type of trading for a professional is desirable because you don't have to know the direction of the underlying or even understand pricing models to make money. I don't believe that this type of trading is practical for the retail investor. Also remember that ATM LEAP puts will have a lower delta than the calls. Both ATM LEAP calls and puts will have a much flatter delta curve than shorter term options. Hope that this didn't make understanding worse. Regards, Ken

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