Synthetic stock options are option strategies that copy the behavior and potential of either buying or selling a stock, but using other tools such as call and put options. A Synthetic Long Stock is the name for the bullish trade option, which involves buying a call option and selling a put option at the same strike price.
The effect of these synthetic stock options is similar to just buying a basic call option, where your profits are unlimited the higher the stock climbs. However, there are a few key differences. Firstly, a Synthetic Long Stock requires you to sell a put option. Doing so means you will need to close this position before expiration to prevent the put option being exercised.
As can be seen in the chart below, buying a basic call option means that the maximum you will lose is the premium of that call. However, you wont start to see profits till the stock climbs a bit higher than the strike price of the option. In a Synthetic Long Stock, selling a simultaneous put option changes both these characteristics.
- Sell 1 ATM Put
- Buy 1 ATM Call
By combing the profit charts of the call purchase and put sale, it can be seen that the potential loss of the trade has become unlimited. In a basic call option, the maximum you will lose is the premium you spent buying that call. In a Synthetic Long Stock however, you have an open put option which you will need to buy back before expiration, and that put option will cost more the lower the stock price becomes.
However, with this extra risk comes couple of key benefits. Firstly, because you are selling a put option (thus earning premium) together with buying a call, the Synthetic Long Stock becomes cheaper than simply buying a call. In addition, by adding the profit charts of the call purchase and put sale together, you can see that this position starts to see a profit as soon as the stock goes over the strike price.
Synthetic Stock Options copy the potential of buying or selling stock, but using different tools. A Synthetic Long Stock is a bullish strategy and involves buying a call and selling a put. It has unlimited profit as the stock price climbs, and unlimited loss as the stock price falls. Since options are sold, this position needs to be closed before expiration.
A Synthetic Short Stock is the opposite in behavior, and is a bearish strategy. A lot of people think of synthetic stock options as a cheap way of playing basic options, since the option premiums are offset by selling the opposite option contracts. However, please bear in mind that this position is similar to trading in futures. If you wrongly predict the stock direction, these synthetics can become very costly.
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