Thursday, April 23, 2009

Covered Calls and Naked Puts: Synthetic Equivalents

Covered calls and naked puts are synthetic equivalents. They have the same risk/reward profile, meaning they have the same net investment and profit/loss potential, when done at the same strike and expiration. To fully understand this concept you need to understand synthetic positions, put/call parity, options arbitrage, and conversion/reversal arbitrage.

Here are links to 4 articles that explain these topics in detail:

  1. Synthetic Positions

  2. Put/Call Parity

  3. Options Arbitrage

  4. Conversion/Reversal Arbitrage

These are some pretty complex topics but they're essential for understanding why a covered call is the same as a naked put, and vice versa.