Synthetic Long Futures

The synthetic long futures is an options strategy used to simulate the payoff of a long futures position. It is entered by buying at-the-money call options and selling an equal number of at-the-money put options of the same underlying futures and expiration month.

Synthetic Long Futures Construction
Buy 1 ATM Call
Sell 1 ATM Put

This is an unlimited profit, unlimited risk options position that can be created to hedge a short futures position, often as a means to profit from an arbitrage opportunity.

The synthetic long futures strategy is also used when the futures trader is bullish on the underlying futures but seeks an alternative to purchasing the futures outright.

Unlimited Profit Potential

Similar to a long futures position, there is no maximum profit for the synthetic long futures. The futures options trader stands to profit as long as the underlying futures price goes up.

The formula for calculating profit is given below:

  • Maximum Profit = Unlimited
  • Profit Achieved When Price of Underlying > Strike Price of Long Call + Net Premium Paid
  • Profit = Price of Underlying - Strike Price of Long Call - Net Premium Paid
Synthetic Long Futures Payoff Diagram
Graph showing the expected profit or loss for the synthetic long futures option strategy in relation to the market price of the underlying security on option expiration date.

Unlimited Risk

Like the long futures position, heavy losses can occur for the synthetic long futures if the underlying futures price falls dramatically.

The formula for calculating loss is given below:

  • Maximum Loss = Unlimited
  • Loss Occurs When Price of Underlying < Strike Price of Short Put + Net Premium Paid
  • Loss = Strike Price of Short Put - Price of Underlying + Net Premium Paid + Commissions Paid

Breakeven Point(s)

The underlier price at which break-even is achieved for the synthetic long futures position can be calculated using the following formula.

  • Breakeven Point = Strike Price of Long Call + Net Premium Paid

Example

Suppose June Crude Oil futures is trading at $40 and each futures contract covers 1000 barrels of Crude Oil. A futures options trader enters a synthetic long futures position by selling a JUN Crude Oil 40 put for $5100 and buying a JUN Crude Oil 40 call for $4800. The net credit received upon entering the trade is $300.

Scenario #1: June Crude Oil futures rises to $50

If June Crude Oil futures rallies and is trading at $50 on option expiration date, the short JUN 40 put will expire worthless but the long JUN 40 call expires in the money and has an intrinsic value of $10000. Including the initial credit of $300, the trader's profit comes to $10300. Comparatively, this is very close to the profit of $10000 for a long futures position.

Scenario #2: June Crude Oil futures drops to $30

If June Crude Oil futures is instead trading at $30 on option expiration date, then the long JUN 40 call will expire worthless while the short JUN 40 put will expire in the money and be worth $10000. Buying back this short put will require $10000 and subtracting the initial $300 credit taken when entering the trade, the trader's loss comes to $9700. This amount closely approximates the $10000 loss of the corresponding long futures position.

Upfront Investment

Some novice futures traders mistakenly believe that the synthetic long futures strategy requires very little upfront investment. They assumed that by trading options instead of futures, they can avoid posting the margin. Unfortunately, the short put position is subjected to the same margin requirements as a short futures position. Hence, the synthetic long futures position requires more or less the same upfront investment as a regular long futures position.

Synthetic Long Futures (Split Strikes)

There is a less aggressive version of this strategy where both the call and put options involved are out-of-the-money. While a larger upside movement of the underlying futures price is required to accrue large profits, this alternative strategy does provide more room for error.

Synthetic Short Futures

The companion strategy to the synthetic long futures is the synthetic short futures.

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