Options are touted as one of the most common ways to profit from market swings. They offer a low-cost way to invest with less capital whether you're interested in trading futures, currencies, or want to buy shares of a corporation. A synthetic option recreates the payoff and risk pr♕ofile of a particular option using combinations of the underlying instrument and different options.

Options can limit a trader's total investment but they also expose traders to 澳洲幸运5开奖号码历史查询:volatility, risk, and adverse 澳洲幸运5开奖号码历史查询:opportunity costs. A 澳洲幸运5开奖号码历史查询:synthetic option may be th♍e best choice when making exploratory trades or esta🀅blishing trading positions given these limitations.

Options Overview

There's no question that options can limit investment risk. The maximum that can be lost is $500 if an option costs $500. A defining principle of an option is its ability to provide an unlimited opportunity for profit with 澳洲幸运5开奖号码历史查询:limited risk.

This safety net comes with a cost, however, because many studies indicate that the vast majority of options held until expiration expire worthless. It's difficult for a trader to feel comfortable buying and holding an option for too long when faced with these sobering statistics.

Options "Greeks" complicate this risk equation. The Greeks include delta, gamma, vega, theta, and rho and they measureꦫ different levels of risk in an option. Each one adds a different level of complexity to💝 the decision-making process.

The Greeks are designed to assess the various levels of volatility, 澳洲幸运5开奖号码历史查询:time decay, and the 澳洲幸运5开奖号码历史查询:underlying asset in relation to the option. They make choosing the right option a difficult task because there's the constant fear that you're paying too much or that𓄧 the option will lose value before you have a chance to gain profits.

Purchasing any type of option is a mixture of guesswork and 澳洲幸运5开奖号码历史查询:forecasting. There's a talent in understanding what makes one option's 澳洲幸运5开奖号码历史查询:strike price better than another strike price. It's a definitive financial commitment when a strike price is chosen and the trader must assume that the underlying asset will reach the strike price and exceed it to book a profit.

The entire strategy will most likely fail if the wrong strike price is chosen. This can be quite frustrating when a trader is right about the market's direction but picks the wrong price.

Synthetic Options

Many problems can be minimized or eliminated when a trader uses a synthetic option instead of purchasing a vanilla option. A synthetic option is less affected by the problem of options expiring worthless. Adverse statistics can work in a synthetic's favor because volatility, decay, and strike price play a less important role in its outcome.

Synthetic options are available in two types: 澳洲幸运5开奖号码历史查询:synthetic calls and 澳洲幸运5开奖号码历史查询:synthetic puts. Both require a cash or futures position combined with an option. The cash or futures position is the primary position and the option is the protective position. Being long in the cash or futures position and purchasing a put option is known as a synthetic call. A short cash or futures position combined with the purchase of a 澳洲幸运5开奖号码历史查询:call option is a synthetic put.

A synthetic call lets a trader put on a long futures contract at a special spread margin rate. Most clearing firms 🅷consider synthetic positions less risky than outright futures positions and therefore require a lower margin. There can be a margin discount of 50% or more dependinꦐg on volatility.

A synthetic call or put mimics the unlimited profit potential and limited loss of a regular put or call option without the restriction of having to pick a strike price. Synthetic positions can curb the 澳洲幸运5开奖号码历史查询:unlimited risk that a cash or futures position has when traded without offsetting risk. A synthetic option can essentially g♏ive traders the best of both worlds ไwhile diminishing some of the pain.

How a Synthetic Call Works

A synthetic call is also referred to as a synthetic long call, a married call, or a protective call. It begins with an investor buying and holding shares. The investor also purchases an at-the-money put option on the same stock to protect against depreciation in the stock's price.

How a Synthetic Put Works

A synthetic put is an options strategy that combines a short stock position with a 澳洲幸运5开奖号码历史查询:long call option on that same stock to mimic a long put option. It's also called a synthetic long put. An investor who has a short position in a stock purchases an at-the-money call option on that same st😼ocಌk. This action is taken to protect against appreciation in the stock's price. 

Disadvantages of Synthetic Options

Synthetic options have superior qualities compared to regular options but that doesn't mean they don't generate their own set of problems.

A cash or futures position is losing money in 澳洲幸运5开奖号码历史查询:real-time if the market🥀 begins to move against it. The hope is that the option will move up in value at the same speed to cover the losses with the protective option in place. This is best accomplished with an at-the-money option but they're more expensive than out-of-the-money options. This can adversely affect the amount of capital committed to a trade.

Example of a Synthetic Call

Assume the price of corn is at $5.60 and market sentiment has a long side bias. You have two choices: You can purchase the futures position and put up $1,350 in margin or buy a call for $3,000. The outright futures contract requires less than the call option but you'll have unlimited exposure to risk. The call option can limit risk but is $3,000 a fair price to pay for an at-the-money option? How much of the premium will be lost and how quickly will it be lost if the market begins to move down?

Let's assume a $1,000 margin discount in this example. This special margin rate allows traders to put on a long futures contract for only $300. A protective put can then be purchased for only $2,000 and the cost of the synthetic call position becomes $2,300. Compare this to the $3,000 for a call option alone. Booking is an immediate $700 savings.

Put-Call Parity

Synthetic options are possible due to the concept of put-call parity that's implicit in options pricing models. Put-call parity is a principle that defines the relationship between the price of put options and call options of the same class with the same underlying asset, strike🌳 price, and expiration date.

Put-call parity states that simultaneously holding a short put and long European call of the same class will deliver the same return as holding one forward contract on the same underlying asset with the same expiration and a 澳洲幸运5开奖号码历史查询:forward price equal to the option's strike price.

An 澳洲幸运5开奖号码历史查询:arbitrage opportunity exists if the prices of the put and call options diverge so that this relationship doesn't hold. Sophisticated traders can theoretically e🤪arn a risk-free profit. Such opportunities are uncommon and short-lived in liquid markets.

The equation expressing put-call parity is:

$\begin{aligned}&C+PV(x)=P+S\\&\textbf{where:}\\&C=\text{price of the European call option}\\&PV(x)=\text{the present value of the strike price } (x),\\&\qquad\qquad\ \,\text{discounted from the value on the expiration}\\&\qquad\qquad\ \,\text{date at the risk-free rate}\\ &P=\text{price of the European put}\\&S=\text{spot price or the current market value of the un-}\\&\qquad\text{derlying asset}\end{aligned}$​C+PV(x)=P+Swhere:C=price of 💛;the European call🐎 optionPV(x)=the present value&nb🍸sp;of the strike price (x), discounted from the value on the expira🐬tion date at the risk-free rateP=price of the European putS=spot ܫ;price&🤪nbsp;or the current market value of the un-derlying asset​

The Bottom Line

It's refreshing to participate in options trading without having to sift through a lot of information to make a decision. Synthetic options can do just that when they're done right. They can simplify decisions, make trading less expensive, and help to manage positions more effectively.