Synthetic Short Options Strategy For Bear Markets

how to play the synthetic short options strategy

A Synthetic Short options strategy is named so because it is almost similar to a naked short PLUS it has the potential to make additional gains.

It works great in bear markets.

How To Play The Synthetic Short Strategy

The strategy involves

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

(b) BUYING an AT-THE-MONEY Put 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 you are bearish on. The idea is to gain from both the put that you have bought and the call that you have shorted.

Let’s start with an example.

It’s 21 May 2018, (12.30 PM) and a bearish stock we have identified is JUST DIAL.

Just Dial was selected because

(a) Results expected today and it is more a weak number

(b) Just Dial is a Google  competitor and it does not stand a chance unless it rejigs its business model.

Its CMP is 422.

The 31-5-18 420 PE is 22

The 31-5-18 420 CE is 22

Let’s do the trade.

1,400 units in one lot, so the total investment works out to:

1,400 X 22 = 30,800 (at 100% margin, have excluded MTM losses, volatility and risk margins) (for the CE)

+

1,400 X 22 = 30,800 (at 100% margin) (for the PE)

Total = RS 61,600

It’s 1.25 PM now and the rates are:

The CMP is 417

The 31-5-18 420 PE is 23.50

The 31-5-18 420 CE is 21

We are gaining, so let’s book profits:

PE – 1,400 shares X 1.50 (23.50-22) = 2,100 per lot

(PLUS)

CE – 1,400 shares X 1 (22 – 21) = 1,400 per lot

Net Profit = RS 3,500 

We won’t wait for the results and book out now because the gains are fairly good. Know that you can make much more if the stock falls per your expectations.

Also, Just Dial is a volatile stock for which the Long Strangle should work better. Anyway, this too worked out.

UPDATE: At 3.30 PM, the situation was:

The CMP is 4o7

The 31-5-18 420 PE is 26

The 31-5-18 420 CE is 17

Had we squared up at 3.30 PM, our profits would have been:

PE – 1,400 shares X 4 (26-22) = 5,600 per lot

(PLUS)

CE – 1,400 shares X 5 (22 – 17) = 5,600 per lot

Net Profit = RS 11,200 

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 3,000 per trade, book out when your losses hit your targets.

When to Enter Into A Synthetic Short

  1. In extremely bearish stocks.
  2. In stocks that are bearish in the near term but can be bullish or neutral in the long run.
  3. When the general market is falling and declines outnumber advances by a wide margin.

Caution

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

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5 Comments on "Synthetic Short Options Strategy For Bear Markets"

  1. sir what to do ..Like BharatForge CMP. is 728 , but it doesnt have 730 options ,,either u have to go for 720 or 740 ,,,

  2. How do we find out, advance/declines margin gap for individual stocks? I can see NSE website having an indicator on their home page. [advance, decline, unchanged]

    • I found the advance/decline. Please ignore above query.

      Today after 3:30 pm, I have analyzed the OI data and short listed few shares for tomorrow’s Short Option’s strategy for bear market.
      (APOLLOTYRE, CHENNPETRO, GODREJIND, KSCL, SIEMENS)
      In 2 days these have already tanked approximately 5.46%.
      Should I still consider these for tomorrow’s Options trade? Please advise.

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