Option Strategies – Synthetic Short (risk conversion)

Option Strategies – Synthetic Short (risk conversion)

The synthetic short stock options strategy consists of simultaneously selling a call option and buying the same number of put options at the same strike price. Both options must be in the same expiration cycle. As the strategy’s name suggests, a synthetic short stock position replicates shorting say 100 shares of stock.

Synthetic Short Stock Strategy Characteristics

 

Synthetic Short Strategy ‘s general characteristics:

Max Profit Potential – it defined by below where the selling and buying the same strike price can result in debit or credit net premium. Breakeven point is simple as explained below

Max Loss Potential: Unlimited

Expiration Breakeven

If the synthetic is entered for a debit premium then breakeven point is =  Strike Price – Debit Paid

If the synthetic is entered for a credit then breakeven point is = Strike Price + Credit Received

 

Synthetic Short Strategy Trade example ?

Profit/Loss Potential at Expiration
In the following example, we’ll replicate a short share position from the following options:

Call Price 65

Strike Price 1000

Put Price  14

 

Now, we simultaneously sell the 100 call and buy the 100 put. When trading synthetic stock positions, you can use any strike price, as long as you purchase the put and sell the call at that strike in the same option expiration cycle.

Normally We choose to use the ATM (at-the-money) options as they are the most actively traded options which benefits traders in terms of liquidity.

Say stock price is trading for 1000 when entering the position:

Initial Stock Price: 1000

Synthetic Short Stock Setup:

Short 100 call for 4

Long 100 put for 3.5

Credit Received for Synthetic: 4 received – 3.5 paid = 0.5

Breakeven Price: 1000 strike price + 0.5 credit received = 1000.5

Here the position’s breakeven is only 0.5 above the current stock price.

What is Synthetic short stock expiration risk graph?

The risk profile of a synthetic short stock position is identical to an actual short stock position. The only difference is the breakeven price, which is miniscule. when trading synthetic short stock positions, the stock price must decrease from the point of entry for us to make profits.

Maximum Loss Potential: Unlimited