Synthetic Long Call

Synthetic Long Call

A Synthetic Long Call strategy is a position where a long stock position is combined with a long put option. The purchase of a put option while still owning stocks is a strategy with a limited loss and (after subtracting the put premium) unlimited profit.

Unlike the synthetic long put position, the synthetic long call strategy is a bullish strategy with limited risk. The investor expects the price of stocks to go up hoping to make profit on the increase, but he or she still wants to curtail the risk in case his expectation won't realize and the stocks go down instead.

The synthetic long call strategy is a very common strategy.

When to use a synthetic long call?

The synthetic long call position is often entered into when the investor needs to hold the stock to for example gain voting power at the shareholder's meeting but is also concerned about near-term downside risk.

In the synthetic long call strategy, the investor can hold his or her stocks, and if the price of stocks goes down, he will make a profit on the decline from the long put option position that will cover the loss he or she incurs on the long stock position.

What is the risk/reward profile of a synthetic long call?

The profit of synthetic long call is unlimited. The price of the stock can grow indefinitely.

Losses are in the synthetic long call strategy limited as long as the put option is owned.

What is the difference between the synthetic long call and a pure long call strategy?

The only difference between the synthetic long call strategy and the simple long call strategy is the dividend that is paid during the holding period of the trade. The owner of the stock would receive the dividend, but the owner of a long call option would not.

What is the break-even point?

The break-even point of the synthetic long call position, that is when the investor does not make any money and also does not loose any money on his investment, is at the point where the situation where

profit from the purchase of the stock

= premium paid for the put option

What is the effect of time on synthetic long call?

The effect of time decay on the synthetic long call position is negative. Over time, the time value portion of the put option erodes (i. e. decays). At expiration, the value of the put option will equal its intrinsic value.

What is the effect of volatility on synthetic long call?

If market volatility increases, the call option in the synthetic long call position will increase in price because call option's implied volatility increases. If volatility decreases, the call option will decrease in price.

What is a synthetic position?

In general, a synthetic position, such as the synthetic long call, is a strategy involving two or more instruments that have the same risk-reward profile as a strategy involving only one instrument.


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