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