Synthetic Long Stock

The synthetic long stock strategy combines two option positions: long a call option and short a put option with the same strike and expiration. The net result simulates a comparable long stock position’s risk and reward. The principal differences are the smaller capital outlay, the time limitation imposed by the term of the options, and the absence of a stockowner’s rights: voting and dividends.

Market Outlook

Bullish sentiment among market participants.

When to Use

An investor often employs a synthetic long stock position if they would like exposure to the underlying without actually purchasing stock.

Profit & Loss Chart

Benefit

The synthetic long gives the options trader the ability to go long on a company’s shares even in the absence of those shares.

Risk & Reward

Maximum Profit: Unlimited
Maximum Loss: Substantial

The maximum gain is unlimited, just as with a long stock position. The best that can happen is for the stock to rise to infinity, in which case the theoretical gain would also be infinite. The investor would exercise the Call to buy the stock at the strike price and then sell the resulting stock at the new, high price. The gain would be even higher/(lower) by the amount of the credit/(debit) when the strategy was implemented.

The maximum loss is limited but very substantial. The worst that can happen if for the stock to become worthless. In that case, the investor would be assigned on the Put and would have to buy the stock at the strike price.  The loss would be higher/(lower) by the amount of the debit/(credit). In this worst case scenario, the Call would of course simultaneously expire worthless.

Break Even Point

This strategy breaks even if, at expiration, the stock is above/(below) the strike price by the amount of the debit/(credit) that the investor paid/(received) when the strategy was implemented.

Breakeven = Call strike + Net Debit

(Breakeven =  Put strike – Net Ccredit)

Volatility Changes

Increase In Volatility: Little Effect
Decrease In Volatility: Little Effect

Usually not a major consideration, all other things being equal.  Since the strategy involves being both long and short an option with the same term and strike, any change in implied volatility should roughly be offset.

Time Decay (Theta)

No Effect

Since the strategy involves being both long and short an option with the same strike and term, the effects of time decay will roughly offset each other.