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Trading Weekly Options + Online Video Course: Pricing Characteristics and Short-Term Trading Strategies by Russell Rhoads

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CHAPTER 15

Split Strike Long Spreads

The value of an option contract is primarily based on the underlying market. A call and put option that share both expiration and a strike price are held together by what is commonly called put–call parity. Basically if the stock price, call price, or put price deviate too much from parity an arbitrage trade emerges. This arbitrage situation will arise, professional high-speed trading firms will take advantage of it, and the result will be that the stock, call, and put prices fall back in line with each other.

Synthetic Long and Short

A synthetic long or short stock position may be created by combining a put and call position that share the same strike price. In the case of a synthetic long, a call would be purchased and a put would be sold. As the stock price moves higher the long call would profit and if the stock price were to move down the short put would result in losses. Much like if a stock were purchased, there would be losses incurred through lower prices and gains would be earned if the stock moved higher.

To create a synthetic short position a call option would be sold and a put option would be purchased. A short stock position would lose value if a stock moves higher and a short call would also lose value as a stock moves up in price. Conversely if a stock moves down in price a short stock position benefits as does a long put position.

As a basic example consider the following prices:

XYZ stock at 45.00
XYZ 50 call at 1.50

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