How To Use The Synthetic Long Options Strategy

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A Synthetic Long Stock options strategy is called so because it is almost similar to a naked long PLUS it has the potential to make additional gains with a short.

It works great in BULL markets.

How To Play The Synthetic Long Stock Strategy

The strategy involves

(a) SELLING an AT-THE-MONEY Put option

(b) BUYING an AT-THE-MONEY Call option

with the same expiration date.

Note that as the Call and Put options are to be traded at AT-THE-MONEY  prices, it implies that the strike prices are equal to or very close to the CMP.

You should adopt this strategy for stocks the market is BULLISH on. The idea is to gain from both the call that you have bought and the put that you have shorted.

THIS IS (PREFERABLY) AN INTRA DAY STRATEGY UNLESS YOU ARE SURE OF CONTINUED BULLISHNESS. NOTE THAT CARRYING FORWARD SHORTS IS EXTREMELY HARMFUL FOR YOUR FINANCIAL HEATH.

Let’s start with an example.

It’s 23 May 2018, (10.15 PM) and a bullish stock we have identified is TATA MOTORS  (it’s fallen drastically and there may be short covering).

Its CMP is 313.

The 31-5-18 310 PE is 9.00

The 31-5-18 310 CE is 12.00

Let’s do the trade.

1,500 units in one lot, so the total investment works out to:

1,500 X 9 = 13,500 (at 100% margin, have excluded MTM losses, volatility and risk margins) (for the PE)

+

1,500 X 12 = 18,000 (for the CE)

Total = RS 31,500

It’s 11.35 PM now and the rates are:

The CMP is 314.35

The 31-5-18 310 PE is 7.90

The 31-5-18 310 CE is 13.10

We are gaining, so let’s book profits:

PE – 1,500 shares X 1.10 (9-7.90) = 1,650 per lot

(PLUS)

CE – 1,500 shares X 1.10 (13.10-12) = 1,650 per lot

Net Profit = RS 3,300 

Let’s book out now because the gains are reasonable. Know that you can make much more if the stock rises per your expectations.

I’m posting this article at 11.45 AM. You may check the price and option premium movements throughout the day.

FOLLOW ON AT 3.30 PM and the rates are:

The CMP is 310

The 31-5-18 310 PE is 10.80

The 31-5-18 310 CE is 11.00

We are LOSING:

PE – 1,500 shares X 1.80 (9-10.80) = 2,700 per lot

(PLUS)

CE – 1,500 shares X 1.00 (11-12) = 1,500 per lot

Net LOSS= RS 4.200 

THEREFORE YOU SHOULD USE THIS STRATEGY INTRA DAY AND EXIT ONCE YOU SEE GREEN OR HIT BUDGETED LOSSES. DO NOT WAIT IT OUT.

BUDGETING FOR LOSSES

Remember that trades can go wrong and therefore you always must work with a budgeted loss while playing options. If you are willing to lose no more than Rs 4,000 per trade, book out when your losses hit your targets.

When to Enter Into A Synthetic Long

  1. In extremely bullish stocks.
  2. In a bull run
  3. In stocks that are bullish in the near term (for example, Tata Motors was selected because a bounce back was expected).
  4. When the general market is rising and advances outnumber declines by a wide margin.

Caution

Square up both options at the same time, preferably intra day. Book out as soon as you make some money or hit your budgeted loss number.

 

2 Comments on "How To Use The Synthetic Long Options Strategy"

  1. Excellent.
    Request to also explain
    how to identify Bearish/Bullish Stocks
    (found this on the net, but not sure if this is the list to follow https://www.topstockresearch.com/StocksTrendingUpReport/TopGainersInFiveDays.html)
    and
    How to identify stocks where advances outnumber declines by wide margin and wise versa.

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