# Synthetic Long Stock

The synthetic long stock is an options strategy used to simulate the payoff of a long stock position. It is entered by buying at-the-money calls and selling an equal number of at-the-money puts of the same underlying stock and expiration date.

 Synthetic Long Stock Construction Buy 1 ATM Call Sell 1 ATM 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.

Synthetic Long Stock Payoff Diagram

## Unlimited Profit Potential

Similar to a long stock position, there is no maximum profit for the synthetic long stock. 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 Paid
• Profit = Price of Underlying - Strike Price of Long Call - Net Premium Paid

## Unlimited Risk

Like the long stock position, heavy losses can occur for the synthetic long stock if the underlying stock price takes a dive.

Additionally, a debit is usually taken when entering this position since calls are generally more expensive than puts. Hence, even if the underlying stock price remains unchanged on expiration date, there will still be a loss equal to the initial debit 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 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 stock position can be calculated using the following formula.

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

## Example

Suppose XYZ stock is trading at \$40 in June. An options trader setups a synthetic long stock by selling a JUL 40 put for \$100 and buying a JUL 40 call for \$150. The net debit taken to enter the trade is \$50.

If XYZ stock rallies and is trading at \$50 on expiration in July, the short JUL 40 put will expire worthless but the long JUL 40 call expires in the money and has an intrinsic value of \$1000. Subtracting the initial debit of \$50, the options trader's profit comes to \$950. Comparatively, this is very close to the profit of \$1000 for a long stock position.

On expiration in July, if XYZ stock is instead trading at \$30, the long JUL 40 call will expire worthless while the short JUL 40 put will expire in the money and be worth \$1000. Buying back this short put will require \$1000 and together with the initial \$50 debit taken when entering the trade, the trader's loss comes to \$1050. This amount closely approximates the \$1000 loss of the corresponding long stock position.

## 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).

## Synthetic Long Stock (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 stock price is required to accrue large profits, this alternative strategy does provide more room for error.

## Synthetic Short Stock

The companion strategy to the synthetic long stock is the synthetic short stock. Unlike the synthetic long stock which merely simulates the long stock position, the synthetic short stock is deemed to be superior to the actual short sale of the underlying for a number of important reasons.

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