Synthetic options

We’ve already covered the four fundamental options positions earlier in this unit. This chapter focuses on synthetic versions of those positions.

A synthetic position is a specifically paired set of securities that produces the same risk-and-return profile as another position. In other words, the positions may look different, but their payoff characteristics match.

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 see the equivalence, compare these 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 have 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 see the equivalence, compare these 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 have the same characteristics:

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

Synthetic long puts

Long puts are bearish strategies with limited loss and limited (but significant) gain potential.

A synthetic long put can be created by combining:

• a short stock position, and
• a long call

To see the equivalence, compare these 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 have the same characteristics:

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

Synthetic short puts

Short puts are bullish strategies with limited (but significant) loss and limited gain potential.

A synthetic short put can be created by combining:

• a long stock position, and
• a short call

To see the equivalence, compare these 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 have the same characteristics:

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