Synthetic
Put
Description
Effectively
an insurance policy for covering a short position, the Synthetic Put is the
opposite of a Synthetic Call. Basically, we short the stock and buy an at-the-money
or slightly out-of-the-money (higher strike) call. The net effect is that of
creating the same shape as a standard Long Put but with the same leverage as
shorting the stock, and we create a net credit instead of a net debit.
In
simple terms, this means that we are capping our downside in case the stock
unexpectedly rises through our stop loss. The Long Call will increase in value
if the stock rises, thereby countering the loss in value of the short stock
position.
Market
Opinion
Bearish.
P/L
When
To Use
Use
this strategy if you are bearish and want a net credit by selling the stock
short.
Example
XXXX
is trading at $34.17 on June 1, 2011.
Short
1,000 shares of stock at $34.17.
Buy
10 August 2011 35 strike calls at $2.76.
Benefit
The
benefit is that you are not putting out any capital, yet you are able to
replicate a put and profit from the stock dropping.
Risk
vs. Reward
The
risk is limited if the stock rises. The reward is a net credit.
Net
Upside
Stock
price minus call premium.
Net
Downside
Call
strike price minus stock price plus call premium.
Break
Even Point
Stock
price minus call premium.
Effect
Of Volatility
Effect
Of Time Decay
Negative.
Time decay erodes the value of the call.
Alternatives
Before Expiration
You
can exit the position if the stock increases above the stop loss. Reverse your
position or buy back the stock and keep the log call.
Alternatives
After Expiration
If
the stock drops by more than the premium, then you make a profit at expiration.
