Last updated on February 10th, 2022 , 01:53 pm
The synthetic long stock position consists of simultaneously buying a call option and selling 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 long stock position replicates buying and holding 100 shares of stock.
By owning a call option and selling a put option at the same strike price, the position’s delta exposure will be +100. Compared to buying shares of stock, a trader may be able to enter a synthetic long stock position with a lower margin requirement than buying shares.
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TAKEAWAYS
- The synthetic long stock trade is an advanced options trading strategy.
- The position is created from buying a call option and selling a put option of the same strike.
- The position is suited for very bullish investors who don’t want to pay for the stock.
- Due to the short put, max loss in this strategy is great.
Synthetic Long Stock - Strategy Characteristics
Let’s go over the strategy’s general characteristics:
Max Profit Potential: Unlimited
Max Loss Potential:
If the synthetic is entered for a debit: (Strike Price + Debit) x 100
If the synthetic is entered for a credit: (Strike Price – Credit) x 100
Expiration Breakeven:
If the synthetic is entered for a debit: Strike Price + Debit Paid
If the synthetic is entered for a credit: Strike Price – Credit Received
Estimated Probability of Profit: Approximately 50% because a synthetic long stock replicates owning shares of stock.
To demonstrate these characteristics in action, let’s take a look at a basic example.
Profit/Loss Potential at Expiration
In the following example, we’ll replicate a long share position from the following option chain:
In this example, we’ll simultaneously buy the 100 call and sell the 100 put. When trading synthetic stock positions, you can use any strike price because the breakeven of each position will be the same. We choose to use the at-the-money options because they are the most actively traded options, which benefits traders in terms of liquidity. Lastly, let’s assume the stock price is trading for $100 when entering the position:
Initial Stock Price: $100
Synthetic Long Stock Setup: Long 100 call for $3.53; Short 100 put for $3.44
Debit Paid for Synthetic: $3.53 paid – $3.44 collected = $0.09
Breakeven Price: $100 strike price + $0.09 debit paid = $100.09
As you can see, the position’s breakeven is only $0.09 above the current stock price. The difference is explained by carrying costs that are priced into the options. In this example, the carrying costs stem from the risk-free interest rate, as the stock in this example does not pay any dividends.
The following visual describes the position’s potential profits and losses at expiration:
As we can see here, the risk profile of a synthetic long stock position is identical to an actual long stock position. The only difference is the breakeven price, which is miniscule. To be profitable when trading synthetic long stock positions, the stock price must increase from the point of entry.
Nice job! You’ve learned the general characteristics of the synthetic long stock position. Now, let’s go through a real trade example and visualize the performance of the position through time.
New to options trading? Learn the essential concepts of options trading with our FREE 160+ page Options Trading for Beginners PDF.
Synthetic Long Stock Trade Example
To bring the previous section to life, we’re going to look at a real synthetic long stock example and visualize the position’s performance over time. Here’s the trade setup:
Initial Stock Price: $109.82
Strikes and Expiration: Long 110 call for $4.13; Short 110 put for $4.28; Both options expiring in 45 days
Net Credit: $4.28 in premium collected – $4.13 in premium paid = $0.15 net credit
Breakeven Price: $110 strike price – $0.15 net credit = $109.85
Maximum Profit Potential: Unlimited
Maximum Loss Potential: $109.85 x 100 = $10,985
Let’s see what happens!
As you can see, the performance of a long stock position and synthetic long stock position are identical. When the stock price increases from the point of entry, both positions are profitable. Conversely, when the stock price falls below the entry price, both positions have losses.
Final Word
Congratulations! You now know how to replicate buying shares of stock with options! Be sure to read the summary of main points below.
- This strategy is referred to as “synthetic” because it mirrors a stock position of 100 shares.
- For small accounts wanting upside exposure, synthetic calls are a great alternative to buying more expensive stock.
- Because of the short, unhedged put, max loss is great for synthetic long positions.
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About the Author
Chris Butler received his Bachelor’s degree in Finance from DePaul University and has nine years of experience in the financial markets.
Chris started the projectfinance YouTube channel in 2016, which has accumulated over 25 million views from investors globally.
