Synthetic trades

From MarketsWiki
Jump to navigation Jump to search

HKEX 728x90 v6.gif

A synthetic trade or synthetic position is one that mimics another position constructed of different elements. The result of the synthetic trade is in many ways the same as the position it mimics in that the win or loss is the same, ie it has the same risk-reward profile.

For example, there are several popular synthetic options strategies.

  • A long combo, the combination of buying a call and selling a put, acts as synthetic long stock. If the underlying stock goes up, so will the call, so the long combo's holder will profit from owning the call just as the holder of the stock profits. If the stock advances, however, the combo creator is at risk that the stock will be put to him or her at a loss.
  • A short combo, the combination of buying a put and selling a call, acts as a synthetic short sale of the underlying stock. If the underlying stock declines, the value of the put increases, and the creator of the short combo will profit, similar to someone shorting the stock. If the stock instead advances, the short combo creator is at risk on the short call.
  • A covered call, the combination of buying the stock and selling calls against it, acts as a synthetic short put. The covered call is a neutral-to-bullish position with limited risk and limited return. If the stock price rises or stays the same, it is a winning position. The short put likewise wins and loses if the stock stays flat or rises, and if the put is OTM it also wins if the stock drops but not as far as the breakeven.[1]


There are a few advantages to using synthetic positions as opposed to the alternative standard positions. One benefit to synthetic positions is that it enables traders to take advantage of discrepancies in options theoretical values. The theoretical value or delta of a call and a put is required to equal 100. For example, a put would have a delta of 20 and a corresponding call would have a delta of 80 so the combined delta is 100. If a put had a delta of 23 however, then the trader could arbitrage by buying both the put and the underlying futures contract which would create the same outcome as buying the call.

Synthetic positions are also beneficial to short sellers because you don't need to borrow the actual stock to short sell it. You also do not have to worry about paying dividends on the short stock. [2]