Synthetic Long Put

Synthetic Long Put

A Synthetic Long Put strategy is a position where a short stock position is combined with a long call option position.

Unlike the synthetic long call position, the synthetic long put strategy is a bearish strategy with limited risk. The investor expects the price of stocks to go down for a long time hoping to make profit on the decline, but he or she still wants to curtail the risk in case his expectation won't realize and the stocks go up. The investor would recoup the loss on the short stock from the long call in this case.

Because only a very few investors are willing to expect a bear market, it is human nature to hope for the good, it is not a very popular strategy.

When to use synthetic long put?

The synthetic long put position is often entered into not as a new position but by making an adjustment to an existing long call position. By selling stocks of ABC, that is being short, the investor turns a bullish position (long call) into a bearish position (synthetic long put).

What is the risk/reward profile of synthetic long put?

The profit of synthetic long put is limited only by the fact that the stock price cannot decline below zero.

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

What is the break-even point?

The break-even point of the synthetic long put 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 on the sale of the stock = premium paid for the call

What is the effect of time on synthetic long put?

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

What is the effect of volatility on synthetic long put?

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

Any other secret to this?

A synthetic long put is can also be created as a combination of a short futures position instead of stocks and a long call. It is still a bearish strategy, just the one leg of the strategy is different.

The synthetic long put combination is often used when a trader needs to shift his strategy. A long call by itself is a bullish strategy. If the trader suddenly expects the opposite, he or she enters into the synthetic long put.

This allows him to revise his strategy without the cash flow effect. All that he or she has to do is sell futures. That combined with a long call will give him a synthetic long put.

What is a synthetic position?

In general, a synthetic position, such as the synthetic long put, 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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