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Synthetic Short Stock (Split Strikes)
The synthetic short stock (split strikes) is a more aggressive version of the synthetic short stock. Like the synthetic short stock, this strategy is used to simulate the payoff of a short stock position. It is entered by selling slightly out-of-the-money calls and buying an equal number of slightly out-of-the-money puts of the same underlying stock and expiration date.
| Synthetic Short Stock (Split Strikes) Construction |
| Sell 1 OTM Call Buy 1 OTM Put |
This is an unlimited profit, unlimited risk options trading strategy that is taken when the options trader is very bearish on the underlying security but seeks an alternative to short selling the stock.
Unlimited Profit Potential
Similar to a short stock position, there is no limit to the maximum possible profit for the synthetic short stock (split strikes). The options trader stands to profit as long as the underlying stock price goes down.
The formula for calculating profit is given below:
- Maximum Profit = Unlimited
- Profit Achieved When Price of Underlying < Strike Price of Short Call + Net Premium Received OR Price of Underlying < Strike Price of Long Put - Net Premium Paid
- Profit = Strike Price of Long Put - Price of Underlying +/- Net Premium Received/Paid
Unlimited Risk
Like the short stock position, heavy losses can occur for the synthetic short stock (split strikes) if the underlying stock price makes a sharp move upwards.
Often, a credit is usually 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 Call + Net Premium Received OR Price of Underlying > Strike Price of Long Put - Net Premium Paid
- Loss = Price of Underlying - Strike Price of Short Call +/- Net Premium Paid/Received + Commissions Paid
Breakeven Point(s)
The underlier price at which break-even is achieved for the synthetic short stock (split strikes) can be calculated using the following formula.
- Breakeven Point = Strike Price of Short Call + Net Premium Received OR Strike Price of Long Put - Net Premium Paid
Example
Suppose XYZ stock is trading at $40 in June. An options trader setups a split-strikes synthetic short stock by buying a JUL 35 put for $50 and selling a JUL 45 call for $100. The net credit taken to enter the trade is $50.
If XYZ stock rallies and is trading at $50 on expiration in July, the long JUL 35 put will expire worthless but the short JUL 45 call expires in the money and has an intrinsic value of $500. Buying back this short call 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 short stock position.
On expiration in July, if the price of XYZ stock has instead dropped to $30, the short JUL 45 call will expire worthless while the long JUL 35 put will expire in the money and be worth $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 short stock position.
Synthetic Short 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 downside movement of the underlying stock price is required to accrue large profits, this alternative strategy provides less room for error.