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