Synthetic Relationships
Synthetic relationships are created by using two of the three basic securities – stock, calls and puts – to
artificially create the third
Long Synthetic Stock
Created with a long call and a short put at same strike price & expiration date
If the price of the underlying increases, the long call gains in value while the short put holds
If the price of the underlying decreases, the short put loses value while the long call holds
The result is a position that mimics the behavior of the underlying
EXAMPLE
Pg 65 – XYZ Spot stock price = $100, June 100 call premium = $5, June 100 put premium = $5
Synthetic long stock position created by going long June 100 call and shorting June 100 put
Advantages:
Long call would be paid for in full while short put would be subject to margin requirements, but
financial commitment would be considerably less than $100 per share for long stock (leverage)
Versatility – if stock price rises you can buy back short put and remain long the call
Disadvantages:
Options have finite lives while stock does not – to hold the position after expiration you would
have to roll it to another month (create a synthetic short stock to close out the first position and
then create another synthetic long stock)
Short Synthetic Stock
Created with a short call and a long put at same strike price & expiration date
If the price of the underlying increases, the short call loses value while the long put holds
If the price of the underlying decreases, the long put gains value while the short call holds
The result is a position that mimics the behavior of the underlying
EXAMPLE
Pg 66 – XYZ Spot stock price = $96, May 95 call premium = $4.50, May 95 put premium = $2.50
Synthetic short stock position created by going long May 95 put and shorting May 95 call
Position has a $2 credit – much less than the $96 from shorting the stock
Margin requirements for the short call are more manageable than for shorting the stock
If the price of the underlying falls the short call would be closed out, leaving the long put
position intact (flexibility)
Long Synthetic Call (Protective Put)
Created by going long both a put and the underlying stock
Strike price of the put would be the equivalent strike price of the synthetic call
The result is a position that mimics the behavior of a long call
The rules for break-even, maximum loss, and maximum reward are the same for the actual and
the synthetic
Provides the possibility of unlimited gains with limited loss - - the long stock could increase in value
indefinitely, while if the price falls, the long put adds downside protection to the position
That is, any loss below the strike price of the synthetic call would be offset by an appreciation in the
value of the put.
This strategy is popular among fund managers to protect their long stock on the downside.
The price for this protection is the premium for the put (the max loss).
EXAMPLE
Pg 68 – XYZ stock price $50, Dec 50 put premium $2
Short Synthetic Call
Created by going short both a put and the underlying stock
Strike price of the put would be the equivalent strike price of the synthetic call
The result is a position that mimics the behavior of a short call
The rules for break-even, maximum loss, and maximum reward are the same for the actual and
the synthetic
