SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Synthetic Long Stock for Extreme Leverage


Among the many options strategies, one of the most interesting is synthetic long stock.  This combines a long call and a short put opened at the same strike and expiration. The name “synthetic” is derived from the fact that the two positions change in value dollar for dollar with changes in 100 shares of stock.

image.png


However, the cost to open the position is close to zero and may even produce a small credit.


A couple of examples, both using closing values on May 31, 2018 and both citing options expiring on June 15, exactly two weeks away:

 

            Walmart (WMT) $82.54

            83 call, ask 1.08 = $113

            83 put, bid 1.36 = $131

                        Net credit = $18

 

            Macy’s (M) $34.91

            35 call, ask 0.89 = $94

            35 put, bid 1.17 = $112

                        Net credit = $18


In both examples, the closest to the money strikes were used. Both yielded $18 net credit to open the positions. The differences between strike price and dollar value is estimated as $5 for trading fees.


A period longer than two weeks could have been used as well. Because synthetic long stock involves buying a call and selling a put, longer-term positions do not present the time value problem usually faced by options traders. For example, with the net credit close to zero, the position combines to provide exceptional leverage, control over 100 shares not only for no cost, but for an $18 net credit.


The changes in value will mirror movement in the stock as it moves, point for point. The call’s intrinsic value above its strike is going to be one dollar higher for each point of movement in the stock. If the stock moves downward, the put gains one point for each point lost in the stock; and because the put was short, this represents a loss – in fact, identical to the loss of just owning the stock.


The options are likely to track closer to movement in the stock because time value is going to disappear fast, and extrinsic (volatility) value will be less of a factor in overall premium value as expiration approaches.


Some risk factors to remember:

  1. The market risk in synthetic long stock is the same as that of owning 100 shares of the stock. However, in this example, owning shares costs $8,200 for WMT, or $3,500 for M, either of which can be bought for 50% on margin;  and the short put is subject to margin requirements equal to 20% of the strike values. This means the short put margin cost is lower than the stock purchase cost.
  2. Losses in the short put are mitigated by closing the position, rolling it forward, or buying a later-expiring long put. Losses in long stock cannot be managed in the same way. Losses have to be taken or waited out.
  3. Holding the short put represents the primary risk in the position. However, this is the same downside risk as owning 100 shares of stock. The net cost to open the position is close to zero until the collateral requirements are considered. On a practical level, the most likely outcome would be to close the short put once it becomes possible to take profits, and leave the long call to appreciate. This is the best of both worlds: low-cost call with profit potential paid for by a short put position.

Image result for synthetic long stock


The market risk of an uncovered put is identical to the risk of a covered call. Combined with the limited risk of the long call, this makes synthetic long stock a very conservative trade.


Synthetic positions can also be opened on the short side, combining a long put and a short call. This may seem higher-risk than the synthetic long stock; but it can be made more conservative by covering the call. But as long as the call remains uncovered, synthetic short stock is higher-risk than synthetic long.


Synthetics are intriguing and interesting. They provide the possibility to profit from stock price changes, without needing to buy shares of stock. The offsetting cost/income also makes it practical to use long-term options without needing to worry about time decay. This affects both sides equally, meaning there is no net effect of decay during the period the position remains open.

Michael C. Thomsett is a widely published author with over 80 business and investing books, including the best-selling Getting Started in Options, coming out in its 10th edition later this year. He also wrote the recently released The Mathematics of Options. Thomsett is a frequent speaker at trade shows and blogs on his website at Thomsett Guide as well as on Seeking Alpha, LinkedIn, Twitter and Facebook.

 

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • 4 Directional Options Trading Strategies

    Some Option traders prefer to trade mostly non directional strategies, while other option traders prefer to trade directional strategies.  Well, in the world of Options trading, there is no right or wrong answer. You can create a host of strategies based on your preferences and outlook.

    By Kim,

    • 0 comments
    • 85 views
  • Digging Deeper into the Inflation Threat

    Stoking the Embers of Inflation is one of the more important articles we have written. The Monetary Equation Identity discussed in the article provides a counterintuitive way to think about inflation. It took us a long time to accept that this identity lays out a real case for stagflation.

    By Michael Lebowitz,

    • 3 comments
    • 427 views
  • Does Option Selling Have Positive Expected Returns?

    Academic research refers to the persistent phenomenon of ex-post implied volatility (IV) exceeding realized volatility (HV) as the Volatility Risk Premium (VRP). As it applies to option premiums, this leads to a positive expected return for being a systematic option seller.

    By Jesse,

    • 0 comments
    • 203 views
  • Newton Technical Perspective 6/18/2018

    As we enter the third week of June, sentiment has steadily gotten more optimistic, with sentiment polls like Investors Intelligence having risen now for the 5th straight week, while Bears have dropped down under 18%.  The net plurality now stands at 35%, which is worrisome given that Equity put/call data has also dipped down to levels last seen in late January when equities peaked.

    By Mark Newton,

    • 0 comments
    • 631 views
  • Top 10 Things To Know About VIX Options

    VIX options use the CBOE Volatility Index (VIX) as its underlying asset. VIX options were the first exchange-traded options that allowed investors to trade the market volatility. VIX options can be used as a hedge against sudden market decline, but also as speculation on future moves in volatility.

    By Kim,

    • 4 comments
    • 206 views
  • How Hedge Funds Use Options

    Hedge funds and institutions have been using options to get market leverage for years. Warren Buffett has been known to buy calls and sell puts to get bullish exposure, and so has Carl Icahn. And recently I told my subscribers about a massive options trades that shows just how these big investors use options.

    By Jacob Mintz,

    • 2 comments
    • 304 views
  • Synthetic Short Stock – Higher Risk

    The synthetic long stock is a low-risk, highly leverage strategy. But for synthetic short stock, the risk profile is completely different. For the synthetic long, the combination consists of a long call and a short put, at the same strike, and at the same expiration.

    By Michael C. Thomsett,

    • 0 comments
    • 179 views
  • Trade Decisions: Risk or Profits?

    When trading, I believe very strongly that the best method for accumulating profits over the years is to ignore whether a specific position is currently profitable or is losing money.  When looking at any position, it's always necessary to make a buy/hold/sell decision.  Of course, for most option traders 'hold' wins most of the time. 

    By Mark Wolfinger,

    • 0 comments
    • 166 views
  • How To Protect Your Blind Side

    “The price of protecting quarterbacks was driven by the same forces that drove the price of other kinds of insurance: it rose with the value of the asset insured, with the risk posed to that asset.”  -Michael Lewis, The Blind Side. Counter-intuitively, that is often not the case in the capital markets.

    By Michael Lebowitz,

    • 0 comments
    • 823 views
  • How To Evaluate Options Trading Service

    I'm getting a lot of emails asking me to recommend an options advisory service. If you currently subscribe to an option trading service, or if you’re considering doing so, here are some tips how to select one. Those tips will help you to avoid some costly mistakes. 

    By Kim,

    • 0 comments
    • 243 views

  Report Article

We want to hear from you!


Hi,

i read that:

 

Losses in the short put are mitigated by closing the position, rolling it forward, or buying a later-expiring long put. Losses in long stock cannot be managed in the same way. Losses have to be taken or waited out.

  1. How much ITM can the short put be before closing the synthetic long stock position?
  2. Rolling forward means future expirations?
  3. Buying a later-expiring long put without closing the position at the same strike?
  4. Assignment risk on the short put?
  5. For example is this strategy good now for Illumina stock? ILMN is not over sold but i am bullish.

Thanks

 

Share this comment


Link to comment
Share on other sites
  1. That's really up to you. If you allow the options to go too deep ITM, you risk assignment (which is not a bad thing by itself, unless you don't have enough funds).
  2. Yes.
  3. Not necessarily.
  4. Yes if it becomes too deep ITM.
  5. It can be used on any stock that you are bullish on. 

Share this comment


Link to comment
Share on other sites


Your content will need to be approved by a moderator

Guest
You are commenting as a guest. If you have an account, please sign in.
Add a comment...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoticons maximum are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...

Options Trading Blogs