ITM Call == OTM Put?
- Thread starter qlai
- Start date
It's called synthetic equivalence, a.k.a. put/call parity.
https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/SyntheticOption_Webinar.pdf
The basic idea is that these things act exactly the same with regard to P&L. There can be some practical differences - e.g., if you bought an option that is now DITM and don't want to pay the huge spread to exit it, you can get out synthetically (assuming the OTM equivalent on the other side has a much lower spread, and you don't mind the risk of the residual position) - but in general terms, they behave the same way. Take a look at the risk/reward graph for, say, a short put vs. a covered call, and you'll see it.
https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/SyntheticOption_Webinar.pdf
The basic idea is that these things act exactly the same with regard to P&L. There can be some practical differences - e.g., if you bought an option that is now DITM and don't want to pay the huge spread to exit it, you can get out synthetically (assuming the OTM equivalent on the other side has a much lower spread, and you don't mind the risk of the residual position) - but in general terms, they behave the same way. Take a look at the risk/reward graph for, say, a short put vs. a covered call, and you'll see it.
The value of an ITM option be it call or a put is a sum of two components:
- The intrinsic value, how much the option would pay if it expired right now.
- The "actual" value (not sure the exact term).
Example: stock price is $100, OTM put with strike price at $105. Well if the option expired right now, the option would pay $105 - $100 = $5. This is the intrinsic value. This is the minimum amount the option is worth. Any amount of volatility and time to expiration on the option means the option is worth more, so the actual option price will be $5.5, $6, $10 or whatever.
Thing is, the complement of that option (OTM call in this case) is worth EXACTLY the "extra" amount above the intrinsic value. So a call option at strike $105 will be worth $0.5, $1 or $5, you get this value by subtracting the intrinsic value from the ITM put.
I think this is what the guy means. The intrinsic value is largely worthless from a PNL point of view, all that matters is the "extra".
This is why you can't steal your own hat by "rolling" a loss with options. Say you buy 1 share of stock at $100 and price drops to $95. You lost $5 in PNL but no problemo, just sell an ITM put striked at the original stock price, so sell a put with strike $100. You get the intrinsic value ($5 you lost) plus some extra. Superficially not only you didn't lose any money but in fact made some! Only the loss is still there, but camouflaged.
- The intrinsic value, how much the option would pay if it expired right now.
- The "actual" value (not sure the exact term).
Example: stock price is $100, OTM put with strike price at $105. Well if the option expired right now, the option would pay $105 - $100 = $5. This is the intrinsic value. This is the minimum amount the option is worth. Any amount of volatility and time to expiration on the option means the option is worth more, so the actual option price will be $5.5, $6, $10 or whatever.
Thing is, the complement of that option (OTM call in this case) is worth EXACTLY the "extra" amount above the intrinsic value. So a call option at strike $105 will be worth $0.5, $1 or $5, you get this value by subtracting the intrinsic value from the ITM put.
I think this is what the guy means. The intrinsic value is largely worthless from a PNL point of view, all that matters is the "extra".
This is why you can't steal your own hat by "rolling" a loss with options. Say you buy 1 share of stock at $100 and price drops to $95. You lost $5 in PNL but no problemo, just sell an ITM put striked at the original stock price, so sell a put with strike $100. You get the intrinsic value ($5 you lost) plus some extra. Superficially not only you didn't lose any money but in fact made some! Only the loss is still there, but camouflaged.
I think the term you're looking for is 'extrinsic'.
In fact, you've added a bit to the loss by paying the spread again - but rolling can still make sense in some situations. At least if you don't delude yourself about it being some sort of a "fix" (which it's not.) E.g., if I'm short a put in an underlying that I believe will bounce back and the credit for rolling it out is high, I'm most likely going to take that trade. It adds to the premium that I've received, moves my break-even down, and lowers my basis for the stock if I do get assigned later on.
I agree with the response, but the title of this thread is wrong and a bit misleading. It should say ITM Call + stock == OTM Put (same strikes)?
Yeah, it's not that bad. Selling a deep ITM put behaves much like being long stock, with the nice addition that you're being paid to take that position (in the form of the extrinsic value of the put). If stock goes down and you'd be long stock, you'd be losing money. But with the short put you get a little "buffer" through that extrinsic amount so you lose less than a naked long stock. And if stock stays at level or goes up a little, you actually make a bit more. Effectively someone pays you to buy that stock.
Right, that makes sense. What threw me off is when he said “Do you know that when you buy ITM call you are actually buying OTM put?” I took it literally.