What is Synthetic Long ( risk reversal) Option strategies?
A synthetic long Option strategy is for options trading that is designed to mimic a long stock position. Traders create a synthetic long asset by purchasing at-the-money (ATM) calls and then selling an equivalent number of ATM puts with the same date of expiration.
Synthetic long assets carry an infinite amount of risk, but they also carry an infinite amount of potential return. The synthetic long asset position is a less expensive approach to trade than buying a comparable number of shares of the underlying stock outright. Because the cost of the call options is at least partially offset by the money obtained for selling the put options, it can be established with very little capital.
Trade setup for Synthetic Long ( risk reversal) Option strategies?
Synthetic long assets are a double-edged sword since they have an infinite profit and loss potential.
Synthetic long assets, like long stock positions, are not subject to a profit cap. The trader will continue to benefit as long as the underlying stock continues to rise. Profit is calculated using the following formula:
The profit is calculated by adding the profit from long call options to the revenues from the sale of put options, minus the call option premiums paid and any transaction expenses.
When the price of the underlying stock goes up over the strike price of the long call options purchased prior to the options’ expiration date, profit is generated.
The flip side of the coin is that synthetic long positions have an unlimited risk or loss potential.
If the price of the underlying asset falls dramatically, synthetic long assets can suffer significant losses. In this case, the call options expire worthless (provided the underlying asset remains below the call option strike price), and the put options, because they are short, expose the investor to potentially unlimited losses.