The synthetic short stock (split strikes) is a less aggressive version of the synthetic short stock strategy.
The synthetic short stock (split strikes) position is created 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.
Buy 1 put at the put strike price; Sell 1 call at the call strike price. Use the same expiration date.
The split strike version of the synthetic short stock strategy offers some upside protection. If the trader's outlook is wrong and the underlying stock price rises slightly, they will not suffer any loss. On the flip side, a stronger downward move is necessary to produce a profit.
Profits and losses with a split strike strategy are also not as heavy as a corresponding short stock position as the strategist has traded some potential profits for upside protection.
Profit potential
Profit is bounded for the stated stock/index position.
Put strike price minus net opening cost.
Loss potential
Loss can increase without a finite upper bound as the underlying rises.
Unlimited as the stock price rises.
Breakeven points
The breakeven can change depending on which strikes the stock finishes between.
Calculate the breakeven prices
- Put strike price minus net opening cost. Use this result only if it is at or below the put strike price.
- Prices between the put strike price and the call strike price all break even only when the net opening cost equals zero.
- Call strike price minus net opening cost. Use this result only if it is at or above the call strike price.
Ignore results below zero. A boundary price listed twice is a single breakeven.
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.
Scenario #1: XYZ stock price falls slightly to $35
If the price of XYZ stock drops to $35 on expiration date, both the long JUL 35 put and the short JUL 45 call will expire worthless and the trader keeps the initial credit of $50 as profit.
Scenario #2: XYZ stock rallies explosive to $60
If XYZ stock rallies and is trading at $60 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 $1500. Buying back this short call will require $1500 and subtracting the initial $50 credit taken when entering the trade, the trader's loss comes to $1450. A heavier loss of $2000 loss would have been suffered by a corresponding short stock position.
Scenario #3: XYZ stock price falls to $20
On expiration in July, if the price of XYZ stock has instead crashed to $20, the short JUL 45 call will expire worthless while the long JUL 35 put will expire in the money and be worth $1500. Including the initial credit of $50, the options trader's profit comes to $1550. Comparatively, a corresponding short stock position would have achieved a greater profit of $2000.
Commissions
These examples exclude commissions and fees. Include all transaction costs when evaluating the profit or loss of a position.
Synthetic Short Stock
There is a more 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.
Net opening cost means everything paid to open the position, less everything received. Include the shares as well as the options. If opening the position brings in money overall, treat that cost as a negative amount.
Amounts are per share before fees. Multiply by the shares covered by the position; standard equity options usually cover 100 shares per contract. If a maximum profit or loss calculation gives a negative amount, use zero. These figures assume matching contracts held to expiration and do not include financing or early assignment.
Financial mechanics reviewed:
Sources: OIC strategy reference; OIC assignment guidance. Formulas use the stated payoff assumptions; examples are illustrative, not market quotes. Editorial standards and corrections.