Fundamentals
Generate Income,Trade Options Like a Pro
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Options Strategies Put Call Parity- Arbitrage.
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This article will enter into the additional calculation called time-value, noted as 'B' for bond. To be more specific, the amount of money needed to buy or sell the underlying instrument, just as if you will need to pay interest rate on borrowing. The calculation is basically: contract’s days to expiration divided by the yearly interest rate. Most commonly, rates used are the two-year Treasury bills or the 'LIBOR'. CBPS: Call + Bond = Put + Stock, or C + B = P + S. Put = C – S + B. To form a synthetic put, buy a call option and sell the stock. So far, this is just as we already know from previous chapter about synthetic contracts, only this time we are adding the time value. The logic behind buying a bond is since we are selling the underlying instrument, the most efficient way to preserve cash is to buy a bond accumulating interest. It is only logical that the put option price is in a counter correlation to interest rates changes in the markets. This means if the interest rate lifts, one can expect that a put option’s value will lower because of the long bond position that will accrue more interest and consequently, holding this put position is cheaper now. Holding phrase refers to the time value. To form a synthetic call, buy a put option, buy the underlying and sell short a bond. Rationalization for selling bond short is to fund the buying of the underlying instrument. One needs to sell short a bond and to be committed to paying the interest accrued. It is logical that the call option price is in correlation to interest rate changes in the markets. This means, if interest rates lifts, you can expect call's options value to lift as well because of the bonds price depreciation. For example, if a bonds par value is $100.00, at 2% interest rate the bond’s price will be very close to $98.00 depending on the number of days to expiration. If interest rate lifts to say 10%, the bond’s price will drop to close to $92.00. In a higher interest rate environment, a call option is much more expensive to hold, because of a higher interest rate obligation. Hold phrase refers to time value. Stock = C - P + B. To form a synthetic stock, buy a call option and sell a put option. With the amount of money needed to cover the stock buying, buy a bond. The combination of call and put acts as an underlying, just as we have studied in the 'synthetic underlying instrument' article. Examining this combination's Greeks, we will see that delta represents ONE or 100 deltas at any price, time, implied volatility or interest rate. Example Examining also the prices, you can see that selling short the put at $7.04 and buying the call option at $4.06 will leave us with credit of $2.98, which represents the deference between the underlying price $90.00 and the strikes $93.00 and discounted interest rate. |
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If the underlying price rises to $100.00, with the implied volatility at 25%, interest rate at 6%, 104 days to expiration, the $93.00 strike call option deltas will be at 0.76. Therefore the put options deltas should be equal to 1-call options delta 0.76, that is, 0.24. Examining the prices you can see that selling short the put at $2.04 and buying the call option at $10.05 will leave us with $8.01, which represents the deference between the underlying price of $100.00 and the interest rate 1.01 and the strikes $93.00. Once again, we see that holding a call option is much more expensive than holding a put option, a situation when the call option deep in the money and interest rate was 6%, it cost $1.01. On the other hand, holding a position where the put option is deep in the money and interest rate is even lower, we see that there even is a discount. B = P - C + S To form a synthetic bond sell a call option, buy a put option, and buy stock. The combination of call and put acts as a short underlying, just as we have studied in the 'synthetic underlying instrument' article and by buying the long stock, cancel each other and let the time value to play its role, just as we studied in the last paragraph. |
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