The synthetic short futures is an options strategy used to simulate the payoff of a short futures position. It is entered by selling at-the-money call options and buying an equal number of at-the-money put options of the same underlying futures and expiration date.
|Synthetic Short Futures Construction|
|Buy 1 ATM Put|
Sell 1 ATM Call
This is an unlimited profit, unlimited risk futures options position that can be constructed to hedge a long futures position, often as a means to profit from an arbitrage opportunity. The synthetic short futures strategy is also used when the futures trader is bearish on the underlying futures but seeks an alternative to selling the futures outright.
Similar to a short futures position, there is no maximum profit for the synthetic short futures. The options trader stands to profit as long as the underlying futures price goes down.
The formula for calculating profit is given below:
Like the short futures position, heavy losses can occur for the synthetic short futures if the underlying futures price shoots upwards.
The formula for calculating loss is given below:
The underlier price at which break-even is achieved for the synthetic short futures position can be calculated using the following formula.
Suppose June Crude Oil futures is at $40 and each contract covers 1000 barrels of Crude Oil. An options trader enters a synthetic short futures position by buying a JUN Crude Oil 40 put for $5100 and selling a JUL 40 call for $4800. The net credit taken to enter the trade is $300.
If June Crude Oil futures rallies and is trading at $50 on option expiration date, the long JUN 40 put will expire worthless but the short JUN 40 call expires in the money and has an intrinsic value of $10000. Buying back this short call will require $10000 and subtracting the initial $300 credit taken when entering the trade, the trader's net loss comes to $9700. Comparatively, this is very close to the net loss of $10000 for the short futures position.
If June Crude Oil futures is instead trading at $30 on option expiration day, then the short JUN 40 call will expire worthless while the long JUN 40 put will expire in the money and be worth $10000. Including the initial $300 credit received on entering the trade, the trader's profit comes to $10300. This amount closely approximates the $10000 gain of the corresponding short futures position.
Some novice futures traders mistakenly believe that the synthetic short 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 call position is subjected to the same margin requirements as a long futures position. Hence, the synthetic short futures position requires more or less the same upfront investment as a regular short futures position.
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 downside movement of the underlying futures price is required to make large profits, this split strikes strategy does provide more room for error.
The converse strategy to the synthetic short futures is the synthetic long futures, which is used when the options trader is bullish on the underlying but seeks an alternative to purchasing the futures itself.
To buy or sell futures, you need a broker that can handle futures trades.
OptionsHouse is a full fledged Futures Commission Merchant that provides a streamlined access to the futures markets at extremely reasonable contract rates.Click here to open a futures trading account at OptionsHouse.com now!
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...]
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...]
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...]
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...]
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...]
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...]
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 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...]
Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]
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...]
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...]
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...]