Why doesn't this options investing strategy work?

Question

I am trying to understand a certain investing strategy involving options. In the example I'm looking at, it seems one can obtain a stock for less than its market price, so there must be something I am missing.

Say I think stock in company X will go up in value, and I plan to buy one share now and sell it in a year. But alternatively, I could choose some price c, buy one call option and sell one put option, both with strike price c and expiration in one year, then put c in escrow to cover the put. My total expense right now is (call option price) - (put option price) + c. At the end of the year, I exercise my call option if and only if the put option I sold was not exercised. The result is, at the end of the year, I have one stock in company X, which I then sell.

I just picked an example at random from an online broker that will sell me call options and let me sell cash-covered put options, and found that (call option price) - (put option price) + c is less than the cost of the stock right now. What's going on here? With call-put strategy, I get a discount on the stock price, so there must be a catch.

Edit: At the time I checked, my broker listed the following prices.

• Share price: $103.94
• Price to buy a call option with strike price $135, expiry 7/16: $0.63
• Price to sell a (cash-covered) put option with strike price $135, expiry 7/16: $32.28

If I purchase a call option, sell a put option, and put down $135 cash to cover the put, my net expense is $103.35, which is cheaper than buying a share directly.

Answer 1

It's not clear why you are comparing buying one share with taking a synthetic long option position which would be for 100 shares.

A synthetic long position is when you sell a short put and use the proceeds to buy a call at the same strike. Since call premiums are usually higher than put premiums for at-the-money strikes, this can usually be done for a small credit. If the strike price (which you call "c") of the synthetic is below the underlying, it will be a debit (ITM call) and if above, for a credit (ITM put). But the common theme is that the combination of both options results in a small amount of time premium cost or credit. For that reason, it mimics just owning the stock, hence the reason it is called synthetic long stock.

From your description, it appears that you think that the strike price "c" is a credit to you when you execute the synthetic long. If so, that's not the case. "C" is what you buy (or sell) the stock for if either contract is exercised.

Because these options involve the same strike and because it yields a very small time premium debit or small time premium credit, you are not going to obtain a stock for (much) less than its market price.

And should you exercise your call at the end of the year, you'll have 100 shares not one stock. In most cases, it's more efficient to sell the call rather than to exercise it to buy stock and then sell the stock (less slippage and fewer commissions if you're still paying them).

One of the problems with questions and answers like this is that there's a good chance that we'll talk past each other based on what you wrote and what the reader thinks you wrote. A far better approach is to provide the stock price, strike price, expiration, dividend (if any) and the respective premiums of the put and the call. Then, there's no confusion about what the strategy is its potential profit and loss.

EDIT:

Based on the quotes that you provided in your edit, the credit from your $135 synthetic long would be $31.65. The intrinsic value of the position is $31.06 (135 - 103.94). Since the credit exceeds the intrinsic value by 59 cents, your cost of acquisition would be $103.35 (103.94 - .59), matching your calculations.

My initial reaction to these numbers was surprise because deep ITM options tend to have wide bid/ask spreads so though possible, a 59 cent credit seemed high. Having then read your comment that your broker averages the bid ask, I'm no longer surprised because if you use the respective bid and ask prices of the options, the credit will be less than 59 cents.