Option Basics: Equivalent Positions

A closer look at interchangeable option strategies and how to optimize your positions.

In our recent Option Trading Guidelines article, I emphasized the importance of understanding equivalent strategies, and more importantly, using the optimum one at all times. Equivalent strategies have the same profit/loss profile but can differ significantly in terms of capital requirements, commissions, or efficiency. The following article from our archives takes a deeper dive into this critical concept, illustrating how mastering equivalents can help you trade more strategically and make better use of your capital.

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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.

Two positions are considered to be equivalent when their profit graphs have the same shape. As a simple example, let's look at the purchase of a call option as compared to another position: the combined purchase of a stock and the purchase of a put.

Example: Suppose that XYZ is trading at 50 and a Jan 50 call is selling for 3. Also, the Jan 50 put is selling for 3. The columns below compare the profitability of buying a call versus the profitability of the combined position of buying 100 shares of stock and buying one put.

Since the "Call Profit" column is exactly the same as the "Stock+Put Profit" column, these two strategies are equivalent.

Obviously, the investments required for the two strategies in the example are not the same — only the profit potential is. In fact, after commissions are included, their profits wouldn't be exactly the same, but their profits graph would still have the same shape: limited losses on the downside and unlimited profit potential to the upside.