Synthetic Long & Arbitrage – Varsity By Zerodha in Spokane-Washington

Published Mar 31, 20
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A synthetic call is an options strategy that uses stock shares and put option to simulate the performance of a call option. This gives the investor a theoretically unlimited growth potential with a specific limit to the amount risked. A synthetic call is an option strategy to create unlimited potential for gain with limited risk of loss.



This strategy is so called because it does not involve using any call options. The strategy is also known as synthetic long call, married put or protective put. A synthetic call, also referred to as a synthetic long call, begins with an investor buying an holding shares. The investor also purchases an at-the-money put option on the same stock to protect against depreciation in the stock's price.

A synthetic call is also known as a married put or protective put. The synthetic call is a bullish strategy used when the investor is concerned about potential near-term uncertainties in the stock. By owning the stock with a protective put option, the investor still receives the benefits of stock ownership, such as receiving dividends and holding the right to vote.

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Image by Julie Bang © Investopedia 2019 Both a synthetic call and a long call have the same unlimited profit potential since there is no ceiling on the price appreciation of the underlying stock. However, profit is always lower than it would be by just owning the stock. An investor's profit decreases by the cost or premium of the put option purchased.

Anything above that amount is profit. The benefit is from a floor which is now under the stock. The floor limits any downside risk to the difference between the price of the underlying stock at the time of the purchase of the synthetic call and the strike price. Put another way, at the time of the purchase of the option, if the underlying stock traded precisely at the strike price, the loss for the strategy is capped at exactly the price paid for the option.

Indeed, the cost of the put portion of the approach becomes a built-in cost. The option's cost reduces the profitability of the approach, assuming the underlying stock moves higher, the desired direction. Therefore, investors should use a synthetic call as an insurance policy against near-term uncertainty in an otherwise bullish stock, or as protection against an unforeseen price breakdown.

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This safety net can give them confidence as they learn more about different investing strategies. Of course, any protection comes at a cost, which includes the price of the option, commissions, and possibly other fees.

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The concept of synthetic options trading strategies is really quite simple. They are strategies that replicate the profit and loss profile of another strategy, but created in a different way. Typically, the strategy being replicated will involve multiple options positions and the synthetic strategy will use a combination of stocks and options.

These strategies aren't as complicated as many traders believe them to be, and they offer a couple of clear advantages in certain circumstances. There are two common reasons for using these strategies. First, you would use them as a simple way to try and profit if your outlook on an existing position changes, because you will see from two of the examples below that they can be used to adjust an existing stock position to try and profit from a period of volatility, or to try and profit from a period of stability.

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By making fewer transactions you would have to pay less in commissions to your broker. The advantages are really that simple; they are an easy way to adjust an existing position and they can save you money. The synthetic straddle emulates the strategy known as the long straddle. A long straddle would usually be created if your outlook was volatile i.

you expected the underlying security to move significantly in price, but you weren't sure in which direction it would move. It's created by buying an equal number of the same calls and puts and it enables you to make profits regardless of which way the price of the underlying security moves, provided it moves at least a certain amount.

There are actually two ways to create one. The first is by owning stocks and also owning twice the amount of at the money puts based on that stock, and the second is by being short on stock and owning twice the amount of at the money calls based on that stock.