Synthetic Options, Real Food

Hi Shoppers,

As a (growing!) trading education firm, a healthy portion of our clients here at Option Pit are fairly new to trading options.

So, I’ve two quick bites for you today that most everyone will find useful …

How to ALWAYS know your risk when trading options and …
Where to get the past patty melt on Chicago’s Northside

First, some quick history …

The Chicago Board Options Exchange (CBOE) was created by Chicago Board of Trade (CBOT) commodities futures traders in 1973.

Now, I’m a Chicago native and still live here … unlike Option Pit CEO Mark Sebastian, who last October decamped for the “better weather” of Austin, Texas. How’s that working out for you these days, Mark?

Anyway, an older gentleman named Cedric who hangs out at Meier’s Tavern, one of our favorite old-time drinking establishments in the northern suburbs, claims he founded the Cboe.

I have yet to pick his brain, but I do pop in occasionally in the hopes of running into him …

And to have a huge stein of DAB beer, as Meier’s is one of the only places that has the delicious German lager on tap.

They also have the best patty melts and tater tots, all served on styrofoam plates.

I swear the dust is still there from when the place opened in 1933!

Meier’s is a great, warm and friendly spot — truly a must-visit if you are in the neighborhood.

Back to Options …
So the Cboe opened on April 26, 1973, the 125th birthday of the CBOT, and only listed call options … puts wouldn’t arrive until four years later.

Can you imagine trading calls without puts!?

If you understand options synthetics, you know exactly what I mean. (More on those in a second.)

Options were created as insurance against stock positions.You can literally create long and short stock positions using calls and puts … they are an incredible way to make money off market swings while managing risk.

Synthetics
So I mentioned the options synthetics, which involves combining two of the three (calls, puts and stock) to synthetically create the third.

I’m going to run through them here, because having these committed to memory will help make you a better trader. Here we go …

Long call + short put = long stock
Short call + long put = short stock

Now, I’m going to stop for a second for a bit of history and a key point about volatility …

In the past, knowing those first two bullet points, along with the dividend and interest, allowed traders to spot mispriced options. It doesn’t happen anymore because everything is electronically quoted, but the market maker I clerked for back in 1986 was scooping a whole dollar on these essentially no-risk trades.

It was insane!

But that is why volatility (price fluctuation) is important now … everything is properly “theoretically” priced by the computers. Volatility is the key to finding strategic money making positions in options.

Back to the synthetics:

Long call + short stock = long put
Short call + long stock = short put
Long put + long stock = long call
Short put + short stock = short call

My advice to traders of all levels … memorize these six bullets!

As long as you know these synthetics, you will know your risk and can better manage your trades.

That’s it for now … think I might run down to Meier’s.

Thanks for Reading … See You Next Tuesday!

Licia Leslie

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