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Synthetic Long Stock (Split Strikes)
The synthetic long stock (split strikes) is a more aggressive version of the synthetic long stock. Similar to the synthetic long stock, this strategy is used to simulate the payoff of a long stock position. It is entered by buying slightly out-of-the-money calls and selling an equal number of slightly out-of-the-money puts of the same underlying stock and expiration date.
| Synthetic Long Stock (Split Strikes) Construction |
| Buy 1 OTM Call Sell 1 OTM Put |
This is an unlimited profit, unlimited risk options trading strategy that is taken when the options trader is bullish on the underlying security but seeks a low cost alternative to purchasing the stock outright.
Unlimited Profit Potential
Similar to a long stock position, there is no maximum profit for the synthetic long stock (split strikes). The options trader stands to profit as long as the underlying stock 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 Received
- Profit = Price of Underlying - Strike Price of Long Call + Net Premium Received
Unlimited Risk
Like the long stock position, heavy losses can occur for the synthetic long stock (split strikes) if the underlying stock price takes a dive.
Often, a credit is taken when establishing this position. Hence, even if the underlying stock price remains unchanged on expiration date, there will still be a profit equal to the initial credt taken.
The formula for calculating loss is given below:
- Maximum Loss = Unlimited
- Loss Occurs When Price of Underlying < Strike Price of Short Put - Net Premium Received
- Loss = Strike Price of Short Put - Price of Underlying - Net Premium Received + Commissions Paid
Breakeven Point(s)
The underlier price at which break-even is achieved for the synthetic long stock (split strikes) can be calculated using the following formula.
- Breakeven Point = Strike Price of Short Put - Net Premium Received OR Strike Price of Long Call + Net Premium Paid
Example
Suppose XYZ stock is trading at $40 in June. An options trader setups a split-strikes synthetic long stock by selling a JUL 35 put for $100 and buying a JUL 45 call for $50. The net credit taken to enter the trade is $50.
If XYZ stock rallies and is trading at $50 on expiration in July, the short JUL 35 put will expire worthless but the long JUL 45 call expires in the money and has an intrinsic value of $500. Including the initial credit of $50, the options trader's profit comes to $550. Comparatively, this is very close to the profit of $500 for a long stock position.
On expiration in July, if the price of XYZ stock has instead dropped to $30, the long JUL 45 call will expire worthless while the short JUL 35 put will expire in the money and be worth $500. Buying back this short put will require $500 and subtracting the initial $50 credit taken when entering the trade, the trader's loss comes to $450. This amount closely approximates the $500 loss of the corresponding long stock position.
Synthetic Long Stock
There is a less aggressive version of this strategy where both the call and put options involved are at-the-money. While a smaller upside movement of the underlying stock price is required to accrue large profits, this alternative strategy provides less room for error.