Long Put Synthetic Straddle

The long put synthetic straddle recreates the long straddle strategy by buying the underlying stock and buying enough at-the-money puts to cover twice the number of shares purchased. That is, for every 100 shares bought, 2 put contracts must be bought.

Long Put Synthetic Straddle Construction
Buy 2 ATM Puts
Long 100 Shares

Long put synthetic straddles are unlimited profit, limited risk options trading strategies that are used when the options trader feels that the underlying asset price will experience significant volatility in the near future.

Long Put Synthetic Straddle Payoff Diagram
Graph showing the expected profit or loss for the long put synthetic straddle option strategy in relation to the market price of the underlying security on option expiration date.

Unlimited Profit Potential

Large gains are made with the long put syntethic straddle when the underlying asset price makes a sizable move either upwards or downwards at expiration.

The formula for calculating profit is given below:

  • Maximum Profit = Unlimited
  • Profit Achieved When Price of Underlying > Purchase Price of Underlying + Net Premium Paid OR Price of Underlying < Strike Price of Long Put - Net Premium Paid
  • Profit = Price of Underlying - Purchase Price of Underlying - Net Premium Paid OR Strike Price of Long Put - Price of Underlying - Net Premium Paid

Limited Risk

Maximum loss for the long put synthetic straddle occurs when the underlying asset price on expiration date is trading at the strike price of the put options purchased. At this price, both options expire worthless, while the long stock position achieved breakeven. Hence, a maximum loss equals to the net premium paid is incurred by the options trader.

The formula for calculating maximum loss is given below:

  • Max Loss = Net Premium Paid + Commissions Paid
  • Max Loss Occurs When Price of Underlying = Strike Price of Long Put

Breakeven Point(s)

There are 2 break-even points for the long put synthetic straddle position. The breakeven points can be calculated using the following formulae.

  • Upper Breakeven Point = Purchase Price of Underlying + Net Premium Paid
  • Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

Example

Suppose XYZ stock is trading at $40 in June. An options trader executes a long put synthetic straddle by buying two JUL 40 puts for $200 each and buying 100 shares of XYZ stock for $4000. The net premium paid for the puts is $400. 

If XYZ stock plunges to $30 on expiration in July, the two JUL 40 puts expire in-the-money and has an intrinsic value of $1000 each. Selling the put options will net the trader $2000. However, the long stock position suffers a loss of $1000. Subtracting the initial premium paid of $400, the long put synthetic straddle's profit comes to $600.

On expiration in July, if XYZ stock is still trading at $40, both the JUL 40 put options expire worthless while the long stock position broke even. Hence, the long put synthetic straddle suffers a maximum loss which is equal to the initial net premium paid of $400 taken to enter the trade.

Long Call Synthetic Straddle

The synthetic straddle can also be implemented using calls instead of puts and that strategy is known as the long call synthetic straddle.

Note: While we have covered the use of this strategy with reference to stock options, the long put synthetic straddle is equally applicable using ETF options, index options as well as options on futures.

Commissions

For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.

However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).

Similar Strategies

The following strategies are similar to the long put synthetic straddle in that they are also high volatility strategies that have unlimited profit potential and limited risk.

Strip
Strap
Short Put Ladder

Short Put Synthetic Straddle

Since the long straddle can be synthetically constructed, similarly, the short straddle can be reconstructed using the short put synthetic straddle strategy. Short put synthetic straddles are utlized when the underlying asset price is perceived to be non-volatile.

Ready to Start Trading?

Open an account at OptionsHouse.com and get 100 commission-free trades + free virtual trading tool!

Your new trading account is immediately funded with $5,000 of virtual money which you can use to test out your trading strategies using OptionHouse's virtual trading platform without risking hard-earned money.

Once you start trading for real, your first 100 trades will be commission-free! (Make sure you click thru the link below and quote the promo code '60FREE' during sign-up)

Click here to open a trading account at OptionsHouse.com now!

Continue Reading...

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®.... [Read on...]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]

From Around The Web



Follow Us on Facebook to Get Daily Strategies & Tips!



You May Also Like



Synthetic Positions

Options Strategies

Options Strategy Finder

Outlook on Underlying:


Profit Potential:


Loss Potential:


Credit/Debit:


No. Legs:





Home | About Us | Terms of Use | Disclaimer | Privacy Policy | Sitemap

Copyright 2016. TheOptionsGuide.com - All Rights Reserved.