1991issue C011-9
Constructing synthetic option positions with puts and spreads
A synthetic security is assembled by buying and writing options so the combined profit-and-loss path emulates another single instrument. Long stock with a long put and a short call at matched exercise prices can freeze later value, and the same construction method extends to futures and to split exercise prices.
- A synthetic security is assembled by buying and writing options so the combined profit-and-loss path emulates another single instrument.
- A long put benefits from a decline the way a short stock would, while loss on a rise is limited to the put premium.
- Long stock plus a long put plus a short call, with both option exercise prices equal to the stock purchase price, leaves a combined value that does not change with later stock prices.
- The same payoff-construction method also applies to futures and the options derived from them, and the option exercise prices may be split rather than matched.
What a synthetic package is
A synthetic security is assembled by buying and writing options so the combined profit-and-loss path emulates another single instrument. A synthetic option position is a bought-and-written option package, often with stock or futures, assembled so that combined path matches another instrument.
Elementary payoffs
A long stock gains above its purchase price and loses below it. A short stock has the reversed profit-and-loss path.
A long call profits when the stock moves above the exercise price and loses no more than the premium when the stock stays below that price.
A long put is a purchased put that gains as the underlying falls. It benefits from a decline in the stock the way a short stock would, while loss on a rise is limited to the put premium.
Matched-strike overlays
Long stock plus a long put plus a short call, with both option exercise prices equal to the stock purchase price, leaves a combined value that does not change with later stock prices. Overlaying a long put and a short call on an existing long stock can freeze the combined position so later stock moves no longer change its value.
The signed payoff identity of long stock plus a long put minus a short call equals a constant result that does not depend on the underlying price.
An option spread is a simultaneous long and short option pairing, including a conversion-style overlay that can freeze or reshape an existing stock exposure. The matched-strike overlay is that kind of pairing.
Related identities
A long call and a short put at the same exercise price reproduce the profit-and-loss profile of a long stock. A long stock plus a long put reproduce the profit-and-loss profile of a long call.
Futures and split strikes
The same payoff-construction method used with stock options also applies to futures and the options derived from them, and the option exercise prices may be split rather than matched.
All readings on this track · 16 readings
- 1990Synthetic option parity in limit-locked futures
- 1991Constructing synthetic option positions with puts and spreads
- 1991Synthetic stock and protective put payoff construction
- 1993Equivalent option strategies as a capital and execution checklist
- 1993Keep a futures loss bounded when stops fail
- 2001Financed call ratio repair for a gapped long
- 2003Synthetic long construction with delta and margin checks
- 2003Cash-covered split-synthetic after a decline
- 2004Constructing synthetic calls and puts with stock
- 2006In-the-money calls as bounded synthetic leverage
- 2006Credit construction of a synthetic long call via futures and a long put
- 2006Convert a support-and-resistance range into one synthetic option procedure
- 2007Long-call adjustment via a synthetic straddle
- 2008Constructing protective puts and synthetic option packages
- 2018An uneven vertical debit spread as a stock proxy
- 2020Out-of-the-money strikes as a delta budget for synthetic futures