Synthetic long stock

Description

If the strike price of two options is the same in a long call / short put combination the postion is equivalent to being long stock(owning shares).  A variation is to use options with different strikes.

When to use

Regardless of which combination ( same or different strikes ) is used the position is either equivalent to buying shares or broadly equivalent and hence represents a bullish leveraged trade. 

Leveraged at around 90%
Margin requirements on the long call, short put pair depend on the volatilty of the underlying stock. At the time of the trade this is typically no more 10% of the value of the exercise price of the options. In the following example the put call pair cost a net $1.00 per share or $1000. If we assume margin on the postion is 10% of the exercise value ($75K ) the position requires $7.5k including the $1000 debit . 

Synthetic long stock (same strike prices)                                                                                                   

Synthetic Long stock

Synthetic long stock (split strike prices)

Synthetic Long stock - split strike


Risk/Reward Characteristics

Like long stock, the potential is unlimited as are losses. Therefore investors must carefully consider the initial size of the spread because the investor could end up being assigned on the short put.

Break-even Point:

If debit spread: Call strike price + spread debit; If credit spread: Put strike price - spread credit

Time Decay: Varies.

If XYZ is near the Long Call strike price, time decay is a negative for the spread. If XYX is near Short Put, time decay is a positive.

Volatility: Neutral. If volatility increases, both options increase in price. Thus, the gain in the call offsets the loss in the put. If volatility decreases, the gain in the put offsets the loss in the call.

Assignment Risk

:The investor must watch XYZ for possible assignment if XYZ declines below the Put's strike.