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Options: Creating A Synthetic Stock Position

Creating synthetic long stock lets you open an options-based position that behaves exactly like 100 shares of stock, but without requiring you to invest in shares. In exchange, you are required to deposit collateral in your margin account equal to the strike value of a short position.

An example: You want to buy 100 shares at $60. You create a synthetic long stock position in options. The following options are available:

September 60 call 2.00
September 60 put 1.52

The synthetic long stock position consists of buying the call and selling the put at the same expiration. This position gives you a good tracking mechanism without stock-based market risk. You buy the 60 call and sell the 60 put:

BUY September 60 call 2.00
SELL September 60 put -1.52
Net cost $0.48

This does not include transaction costs, so a real-life example has to be adjusted to reflect the actual net cash outlay. The chart below summarizes the values of each option at expiration, compared to the value of 100 shares of stock at different closing prices:

Stock Value at expiration 100 shares

price 60 call 60 put net of stock

$65 +3.00 +1.52 + 4.52 +5.00

64 +2.00 +1.52 + 3.52 +4.00

63 +1.00 +1.52 + 2.52 +3.00

62 0 +1.52 + 1.52 +2.00

61 - 1.00 + 1.52 + 0.52 +1.00

60 - 2.00 + 1.52 - 0.48 0

59 - 2.00 + 0.52 - 1.48 - 1.00

58 - 2.00 - 0.48 - 2.48 - 2.00

57 - 2.00 - 1.48 - 3.48 - 3.00

56 - 2.00 - 2.48 - 4.48 - 4.00

55 - 2.00 - 3.48 - 5.48 - 5.00

The slight differences in outcome between the net option positions and the equivalent stock values are caused by the net difference of option cost at a net of 0.48.

The synthetic long stock position costs under $100 even with brokerage fees for the two sides of the position. However, you are required to maintain at least $6,000 in your margin account as collateral. (If you have this or more in your account, no additional deposits are required.) The options synthetic position acts exactly like the stock for much less capital at risk (shares of stock represent one form of market risk, versus tying up capital and exercise risk). This is a truly effective application of leverage, but with lower risks. Synthetic positions are easily overlooked or ignored in the options world. But it opens up a range of potential for swing traders and would-be stock investors. The synthetic short stock position also offers a relatively low-risk alternative to shorting stock.

Synthetics deserve careful consideration. These positions - including the short synthetic strategy - solve many problems relating to both market risk and capital management.

Thomsett Publishing Website