Options – Long And Short Synthetic Strategies
Seeking Alpha Analyst Since 2011
Michael C. Thomsett is a widely published options author. His "Getting Started in Options" (Wiley, 9th edition) has sold over 300,000 copies. He also is author of "Options Trading for the Conservative Investor" and "The Options Trading Body of Knowledge" (both FT Press); and "Options for Risk-Free Portfolios" and "Options for Swing Trading" (both Palgrave Macmillan). Thomsett also writes for www.TheStreet.com and the StockCharts.com Top Advisor Corner
A "synthetic" is any strategy that mirrors the value changes in another security. For example, a short stock synthetic consists of options that gain or lose value in the same way as declining stock; and a long stock synthetic is most advantageous when the stock price rises.
When you set up synthetic long or short stock, you get some incredible advantages. These are easily overlooked. Consider, though:
1. The risk to a synthetic position is no greater than going long or short on stock. But the synthetic position cost is close to zero, and possibly even a net credit.
2. The short stock risk is virtually eliminated using options, but allowing you to play bear markets. Using one long put instead of shorting 100 shares of stock sets this up. The long put is going to increase in value for each point lost in the stock. Even so, the maximum loss is the cost of the put. On the upside of this, the short call represents the same risk for short sellers because in theory, the stock price could rise indefinitely. But call sellers can close the position, cover it, or roll forward. Shorting stock provides no chance to roll. However, all uncovered short options require margin collateral equal to 100% of the exercise value, so this could make a difference to many traders, compared to trading shares of stock.
3. Synthetic long stock (one long call, one short put, with the same strike) will mirror movement in the underlying stock, and works best on the way up. Synthetic short stock (one long put, one short call) will also mirror the stock's movement, and is most profitable when the stock declines.
The point is, synthetic positions cost virtually nothing but act just like stock. And by the way, for those worried about opening short calls, imagine the advantage of synthetic short stock with a covered call (a collar). You get the downside advantages with none of the upside risks.
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