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Market Measures

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Put-Call Parity | No Free Lunch (or Arbitrage)

Market Measures

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Assuming you are an ordinary trader and not some super intelligent, hyper fast artificial intelligence then there is no such thing as a risk free trade in the markets as we explain here. If you've ever thought you spotted a risk free trade and it was still there a second later then you need to watch this segment.

Financial markets are very efficient and any arbitrage opportunity lasts only milliseconds before high speed computers pounce on it and eliminate it. There are no mispriced positions that can be offset for a guaranteed profit.

This is the foundation of the put-call parity, which shows that a call can be constructed from puts and vice versa. Puts and Calls must trade at parity with a synthetic position otherwise there would be a potential for arbitrage. A call plus cash equals a put plus the stock or, performing some simple algebra we can say that stock minus a call equals cash minus a put. A graph of the payoffs for a long stock, short call and a short put position were displayed. The showed that the two positions are identical at expiration.

When it appears that something is mispriced there is always a reason for it. This can include stocks that are very hard or impossible to borrow. An example of this in GPRO was displayed in a table. The table included a GPRO $81 short synthetic strategy using October options on September 25th 2014, the price or debit of the trade, the cost basis and the then stock price of GPRO.

A box spread can also demonstrate this concept. Even if it can be put on profitably commissions will eat up any risk free profit.

Watch this segment of “Market Measures” with Tom Sosnoff and Tony Battista for the valuable takeaways and why the market don’t provide you with a free lunch. Don't try to grift a grifter.

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