Simple Stock Options Training That Can Save You Money
Stock Options are a very powerful investing and trading vehicle. At YP Investors we want to make sure you have as much knowledge as possible about them. This is why we created our Stock Options Training posts.
Did you know that there is an equivalent option position to any option position? These options positions are different ways of investing in a stock but provide the same result. When we say equivalent we mean that both options positions for a particular underlying stock will earn or lose the same amount at any price. So why use an equivalent option position? Because they provide you with alternative ways to invest and can save you money. When using alternative strategies you can free up more money and save on commissions!
It First Blows Your Mind, Then You Realize It’s Simple
To start our stock options training in equivalence we will attempt to blow your mind with an easy example. This one is the most popular example of options equivalence: Writing a Covered Call is the same as Selling a Naked Put. The following options positions are equal:
- Buy 500 shares of XYZ and sell 5 December calls at $50 strike price
- Sell 5 December puts for XYZ at $50 strike price
Here is how they are equal:
- At Expiration XYZ is above $50
- For option position 1: The call owner will exercise the options and you will sell your 500 shares of XYZ at $50 per share. You now have no more shares of XYZ.
- For option position 2: The $50 puts expire worthless and you have no position/shares in XYZ.
- At Expiration XYZ is below $50
- For option position 1: The $50 call options expire worthless and you still have 500 shares of XYZ.
- For option position 2: The put owner will exercise the options and you have to buy 500 shares of XYZ at $50 per share, so now you own 500 shares of XYZ.
How You Can Save Money With Options Equivalence
There are actually a couple of ways to save yourself money in our first example. If your brokerage account charges commissions per trade you would want to use the Naked Put instead of the Covered Call. With the covered call you will be charged commissions for both purchase and sale of the XYZ shares and for selling the call. In the naked put you are only charged once when you sell the put contract.
Additionally, you can make much more money strictly depending on when you sell the options contracts. It’s all about timing it right. In the Naked Put you can wait until XYZ starts to dip then sell the put. This will make the premium you are paid rise! Likewise if you want to implement the Covered Write, wait until XYZ goes up and sell the call contract. Make sure to use the correct options position so your premium is much higher, putting more money in your pocket!
The Key to Equivalence: S = C – P
All of our Stock Options Training comes down to the simple formula:
S = C – P
Each letter represents the following
- S: Stocks
- C: Call Option Contracts
- P: Put Option Contracts
This equation means that being long 100 shares of a Stock is equivalent to buying 1 Call Option and selling 1 Put Option at the same strike price for the same expiration. (S = C – P)
In our first example we showed that a Covered Call is Equivalent to a Naked Put. The equation is simply re-written as S – C = – P.
Other Common Ways To Use The Formula
This equation can be re-written anyway you desire (as long as you obey the laws of Algebra.) Another common way to view the equation is in this way: C = S + P
This means that buying 1 Call option is equivalent to being long 100 shares of a Stock and buying 1 Put option (the options contracts must have the same strike price and expiration.) If you bought a call option you pay a set premium and only make money if the stock rises in price. If you own 100 shares and buy a put option you are paying a premium to protect those 100 shares of stock if the price drops. You make money if the stock rises in price just like the call.
Finally we will re-write it in one more common way: P = C – S
This means buying 1 Put option is equal to buying 1 Call option and shorting 100 shares of a Stock.
Use YP and Options Equivalence To Grow Your Wealth
We can continue to re-organize the equation and get numerous additional results for options equivalence. One question that consistently comes up using options is how do you pick the correct Stock and Strike Price? YP Investors has Point and Figure Chart and Technical Analysis Tools that display if a stock is good to invest in and clearly shows the buy and sell signals. These can be points of entry and exit for a stock and can provide an accurate prediction for the stocks direction. Learn more about Point and Figure Charting in our Tutorial Video.
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We hope you are able to use this information to your advantage and be smarter in your investments. Good luck and continue to grow your wealth with YP Investors.