This article was originally published in The Option Strategist Newsletter Volume 5, No. 4 on February 22, 1996.
An understanding of equivalent positions is mandatory knowledge for option traders. Two positions or strategies are equivalent if their profit graphs have the same shape. For example, we have repeatedly stressed that covered call writing and naked put writing are equivalent. This can be quickly verified by looking at the profit graph on the right. Both strategies have limited profit potential, large downside risk, and can make money if the underlying remains relatively unchanged in price until expiration.
This article was originally published in The Option Strategist Newsletter Volume 2, No. 9 on May 13, 1993.
Covered call writing is not one of our normally recommended strategies, because we prefer ratio writing or the equivalent, since it is a more neutral strategy. However, covered writing is a strategy practiced by many option investors and therefore is a topic worthy of discussion. In this article, we will approach this subject from a slightly different, more sophisticated viewpoint: we will compare the covered call write with the sale of a naked put. In addition, we'll see how this comparison leads us to conclusions regarding neutral strategies such as ratio call writing or straddle and combination selling.
This article was originally published in The Option Strategist Newsletter Volume 2, No. 13 on July 8, 1993.
Two strategies are equivalent when they have the same profit potential. That is, their profit graphs have the same shape. More experienced option traders know that an understanding of equivalent strategies or positions is vital. It can help in many ways. For example, one may be able to more effectively use his capital by establishing the more favorable equivalent strategy. Or, when trading, he may be able to get a better execution. Finally, he may be able to make better adjustments to his positions by using equivalent strategies. The concept is not new, but even a veteran trader may have to sort through some equivalences in order to choose the best position.
This article was originally published in The Option Strategist Newsletter Volume 4, No. 18 on September 28, 1995.
The concept of equivalent option positions is an important one, for it is often possible to substitute one strategy for another. In so doing, one might be able to accomplish additional goals while still preserving the same profit potential. These considerations might include decreased commissions, tighter markets, or better use of capital.
