0

Why can't we just combine multiple options strategies to get an always profitable scenario?

For example by combining protective call and protective put won't we be able to get an always profitable scenario?

enter image description here

enter image description here

  • 4
    Your scales for these 2 images are different. Would you mind telling us where you found them? – JoeTaxpayer Jul 8 '16 at 8:49
  • As JoeTaxpayer notes, you need to cite your images. – Joe Jul 8 '16 at 13:51
  • Yes, you are right the scales are different. – Mike Jul 9 '16 at 3:56
  • Image source : fyers.in/tool-box/options-strategies – Mike Jul 9 '16 at 3:59
  • 1
    TL;dr: Nothing in the market is "always". – keshlam Jul 9 '16 at 5:13
10

In theory, no. In practise, occasionally.

In theory if the market is working correctly the price of a matched put and call in the same stock should align such that there is no profit in buying both. The same goes for any other set of options which are trying to cover all possible outcomes (or indeed for trying to bet on all the runners in a horse race!).

In practise markets aren't perfect and sometimes prices of opposing options will diverge such that there is a small profit to be made. There are people who make a living hunting these opportunities down, and it has a name - arbitrage.

Arbitrage opportunities tend be very short lived; by their very nature they stimulate trades in the affected assets in such a way that they tend to realign the prices towards equilibrium. Being essentially mechanical they are also relatively easy for computerised trading systems to spot and exploit when they do arise.

  • 6
    With today's sophisticated computers, these opportunities are nearly impossible to find. If OP updates his images, he'd find that there's profit only if the stock trades outside a certain range. e.g. One can buy both put and call at $100 strike, and risks the time premiums on both, that's the sunk cost. – JoeTaxpayer Jul 8 '16 at 10:46
  • Did you mean "affected assets?" – Michael Jul 8 '16 at 13:56
  • @Michael I believe I did :) – Nigel Harper Jul 8 '16 at 15:18
1

I think that there's a lot of confusion in the replies to this question, other than Joe Taxpayer who realized that buying a put and a call has a 'sunk cost' and that's the risk in the position.

Editing a bit, the question was:

Why can't we just combine a protective put (PP) and a protective call (PC) to get an always profitable scenario?

Let's assume that these options have the same strike price and expiration.
There are two ways to analyze this. The long way is:

PP = (+ 100 XYZ + 1 put)

PC = (- 100 XYX + 1 call)

Add them together and you have:

PP + PC = (+ 100 XYZ + 1 put) + (- 100 XYX + 1 call)

or

PP + PC = (+ 1 put + 1 call) which is a long straddle.

If the strike prices were different, it would be a long strangle.

Options cost money. Therefore, straddles and strangles have a debit cost and therefore there can never be "an always profitable scenario."

The short way to do this is to understand the Synthetic Triangle which states that there 6 basic synthetic positions relating to combinations of puts, calls and their underlying stock:

  1. Synthetic Long Stock = Long Call + Short Put

  2. Synthetic Short Stock = Short Call + Long Put

  3. Synthetic Long Call = Long Stock + Long Put

  4. Synthetic Short Call = Short Stock + Short Put

  5. Synthetic Short Put = Long Stock + Short Call

  6. Synthetic Long Put = Short Stock + Long Call

    (3) is a Protective Put and is equal to buying a call.

    (6) is a Protective Call and is equal to buying a put.

There is no arbitrage involved in any of this.

  • I think the value of this answer could increase, if you should some simple hypothetical math indicating the profit / loss under different ultimate price results. ie: that profit with this plan will appear if the price is higher than x or lower than y, as a result of what you mention here about the initial cost of these options. – Grade 'Eh' Bacon Sep 17 '18 at 17:39
  • I could do that but then it would entail explaining what a straddle (or strangle) is and what the risk, reward and break even points are. There are ton of option sites that explain these. Here's one for those interested in a more detailed explanation: theoptionsguide.com/long-straddle.aspx – Bob Baerker Sep 17 '18 at 17:50
  • Right but at the level of sophistication of the OP, an answer without numbers is hard to follow and not as impactful. – Grade 'Eh' Bacon Sep 17 '18 at 19:41
  • The link that I provided offers the example of buying a July $40 straddle. It also provides the formulas for calculating the Max Loss, where the Max Loss occurs where the Upper and Lower Breakeven Points are, along with a risk graph. Summarizing all of that to write here is needless work. If the OP can't follow what's in the link, he needs to back off and spend some time with some good option books. – Bob Baerker Sep 17 '18 at 19:56
1

I have actually seen that happening, intentionally.

In Germany, if you put money into a savings account and get interest, you pay tax on the interest. If you buy options and make money or lose money, that's similar to gambling and tax free.

So some enterprising investment company sold capped options betting that the dollar would go up, plus capped options betting that the dollar would go down, cleverly calculated so that no matter where the dollar went, the buyer would make money, slightly less than the usual interest rate - but tax free. German inland revenue closed it down.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.