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Short Synthetic - An Option Trading Strategy

Today, we shall see the short synthetic option strategy in this article. A synthetic strategy is made by combining various individual option contracts. Synthetic strategies are the best choice when you want to modify the existing strategy. It can be used to combine, replicate or mirror the strategy for the benefit.


Market outlook:

In a short synthetic strategy, traders sell a call option contract and buy the put options contract. Both of these contracts must have the same underlying asset and the same expiry date. Traders implement this strategy when they are bearish on the direction of the underlying stock. This options strategy has unlimited profit potential if implemented correctly.


Why use the short synthetic option strategy?

  • These strategies are good for making minor modifications to the existing strategy.

  • When you want to hold the underlying asset and do not want to lose it, you can opt for the synthetic strategy in such cases.

  • As options provide high flexibility, they can be easily swapped under adverse market situations.

  • The synthetic strategy can create arbitrage opportunities.

Break-even point of the synthetic strategy:

The strategy's break-even point is strike price + or - Net premium received or paid.


How to enter the synthetic strategy?

To enter the synthetic strategy, traders must sell the call option and buy 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 short synthetic options strategy:

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

  • Sell the underlying asset on profit

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

Illustration

Eg. Nifty is currently trading @ 5500. A Short Synthetic can be created by selling Call Strike 5500 @ premium of 140 and buying Put Strike 5500 @ 100. Net inflow of premium is 40.

Strategy

Stock/Index

Type

Strike

Premium Inflow

Short Synthetic

NIFTY (Lot size 50)

Buy Put

5500

100 (Outflow)

Buy Call

5500

140 (Outflow)

The Payoff Schedule and Chart for the above is below.


Payoff Schedule

NIFTY @Expiry

Net Payoff (Rs.)

5000

27000

5100

22000

5200

17000

5300

12000

5400

7000

5500

2000

5540

0

5600

-3000

5700

-8000

5800

-13000

5900

-18000


Short Synthetic - An Option Trading Strategy

In the above chart, the breakeven happens the moment Nifty crosses 5540 (since net inflow is ₹40). In such a strategy, risk and reward is unlimited.

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