We habitually underestimate the effects of randomness. Our stockbroker recommends that we invest in the Latin American mutual fund that “beat the pants off the domestic funds” five years running. Our doctor attributes that increase in our triglycerides to our new habit of enjoying a Hostess Ding Dong with milk every morning after dutifully feeding the kids with a breakfast of mangoes and nonfat yogurt. We may or may not take our stockbroker’s or doctor’s advice, but few of us question whether he or she has enough data to give it. In the political world, the economic world, the business world—even when careers and millions of dollars are at stake—chance events are often conspicuously misinterpreted as accomplishments or failures.
—Leonard Mlodinow The Drunkard’s Walk
This chapter explores concepts and strategies that go beyond the basics and some of which carry more risk and a more comprehensive knowledge of options if you plan on “testing” them. Please be sure that you understand any strategy and concept fully before applying in a live market environment. Aside from the strategies contained, this chapter also offers you a deep look into the relationships that options have not only with their underlying asset, but with each other.
PUT-CALL PARITY, INTEREST RATES, DIVIDENDS, AND FORWARDS
There is a balance that exists between calls and puts; in other words, if a call is trading for X, the put, in most cases should be trading for Y and vice versa. I am ...