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Long Synthetic - An Option Trading Strategy

In this article today, we will learn long synthetic options strategies in the Indian financial market. In the trading field, you can make many positions by combining, replicating or making mirror positions with different option contracts.


The Call option contract holder may buy an asset at a specific price and time, and on the other hand, the put option contract sells the same underlying asset at a specific time and price. It indicates some connection between them and can be shown with the put-call parity.


Due to the connection between the call options and the put options, some contracts are called synthetic.


What is long synthetic?

The traders create a synthetic long position by buying a long call option and selling a short put option. Both call and put options must have the same underlying asset and expiry. It works the same as holding the long stock. Traders' expectation from the long synthetic is similar to investing in the long stock (shares) position.


When the trader is bullish on the direction of the stock, he initiates the synthetic strategy. It offers unlimited profit.


Why use synthetic options strategies?

Traders create various positions by combining the long, short, call and put options, which are named the synthetic options strategies. They are formed in such a way that it looks like an individual option contract. Please find the other reasons why traders use synthetic strategies.

  • Synthetic strategies are beneficial for making adjustments to the existing strategy.

  • In case you do not want to lose the underlying asset from your portfolio, you can enter into the synthetic call, it will allow you to hold the asset, and ultimately the ownership will remain with you.

  • Options contracts offer flexibility; in the adverse market, you can easily swap positions without making any changes to the existing ones.

  • You can change the complete position by making minor changes and adjustments.

  • Synthetic strategies can also help initiate an arbitrage opportunity

Breakeven point of the synthetic strategy:

The breakeven point of the strategy is strike price + or - Net premium received or paid.


How to enter the synthetic strategy?

To enter the synthetic strategy, traders have to buy the call option and sell a put option. When these options are further categorized by short and long, it makes various other strategies such as long synthetic call, long synthetic put, short synthetic call and short synthetic put option strategies. It depends on what position you are entering.


How to exit from the synthetic options strategies:

In order to exit from the synthetic options strategy, you have two ways:

  • Sell the underlying asset on profit

  • Let the option expire, and you retain the premium.

Strategy

Stock/Index

Type

Strike

Premium Inflow

Long Synthetic

NIFTY (Lot size 50)

Buy Put

5500

140 (Inflow)

Buy Call

5500

100 (Outflow)

The Payoff Schedule and Chart for the above is below.


Payoff Schedule

NIFTY @Expiry

Net Payoff (Rs.)

5000

-23000

5100

-18000

5200

-13000

5300

-8000

5400

-3000

5500

2000

5600

7000

5700

12000

5800

17000

5900

22000

6000

27000


In the above chart, the breakeven happens the moment Nifty crosses 5460 (since net inflow is ₹40). In such a strategy, risk and reward is unlimited.

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