Synthetic options

We’ve covered the four fundamental options positions earlier in this unit. This chapter will focus on synthetic versions of these positions, which are other sets of specifically paired securities that share the same risk & return profile. In particular, we’ll cover:

• Synthetic long calls
• Synthetic short calls
• Synthetic long puts
• Synthetic short puts

Synthetic long calls

Long calls are bullish strategies with limited loss potential and unlimited gain potential. A synthetic long call can be created by combining a long stock position and a long put. To demonstrate this, let’s compare two sets of positions:

Long ABC 50 call at $4
vs.
Long 100 ABC shares at $50
Long 1 ABC 50 put at $4

Both sets of positions reflect the same characteristics:

• Maximum gain: unlimited
• Maximum loss: $400
• Breakeven: $54

Synthetic short calls

Short calls are bearish strategies with unlimited loss potential and limited gain potential. A synthetic short call can be created by combining a short stock position and a short put. To demonstrate this, let’s compare two sets of positions:

Short ABC 50 call at $4
vs.
Short 100 ABC shares at $50
Short 1 ABC 50 put at $4

Both sets of positions reflect the same characteristics:

• Maximum gain: $400
• Maximum loss: unlimited
• Breakeven: $54

Synthetic long puts

Long puts are bearish strategies with limited loss and gain potential. A synthetic long put can be created by combining a short stock position and a long call. To demonstrate this, let’s compare two sets of positions:

Long ABC 50 put at $4
vs.
Short 100 ABC shares at $50
Long 1 ABC 50 call at $4

Both sets of positions reflect the same characteristics:

• Maximum gain: $4,600
• Maximum loss: $400
• Breakeven: $46

Synthetic short puts

Short puts are bearish strategies with limited loss and gain potential. A synthetic short put can be created by combining a long stock position and a short call. To demonstrate this, let’s compare two sets of positions:

Short ABC 50 put at $4
vs.
Long 100 ABC shares at $50
Short 1 ABC 50 call at $4

Both sets of positions reflect the same characteristics:

• Maximum gain: $400
• Maximum loss: $4,600
• Breakeven: $46