The synthetic long stock position consists of buying a call and selling a put in the same month and at the same strike price. The investor who enters this strategy is going to buy the stock at strike price A if they hold the position until expiration. If the stock price rises above strike price A then the investor will want to exercise the call option and if the stock falls below strike price A the investor will be assigned on the put, so they are going to own the stock at price A one way or another.
However, because the position mimics a long stock position, most investors don’t intend to hold the position until expiration.
The maximum profit is unlimited as owning the stock allows the investor to continue to make money as the stock trades higher.
The maximum loss is also unlimited, at least down to zero, as the stock falls in price losses continue to build up.
The synthetic long stock has a single breakeven point but is calculated differently depending on if the synthetic long stock was acquired for a credit or a debit.
If the synthetic long stock were acquired for a credit, the breakeven would be calculated by subtracting the premium received from the strike price.
If the synthetic long stock were acquired for a debit, the breakeven would be calculated by adding the amount paid to the strike price.
If XYZ is trading $100 and is expected to trade higher over the next three months, a trader could buy a 100-strike price call and sell a 100-strike price put for the following price:
- Buy 1 XYZ 100-strike price call for $4.00
- Sell 1 XYZ 100-strike price put for $$3.50
- Total premium = $0.50 debit
If the stock trades up to $105 at expiration, the investor will make $5.00 on the stock, but because they spent $0.50 on the synthetic long stock, they will have a net gain of $4.50.
If the stock trades down to $95 at expiration, then the trader will get assigned 100-strike price put, buying the stock for $100. This would mean they took a $5.00 loss on the put, but because they bought the synthetic long stock for $0.50, they would have a total loss of $5.50.
There only reason to buy synthetic long stock option would be to achieve the same position as stock but without the high costs of the stock. Of course, this does depend on the trader’s investment bank and margin requirements. Most investors don’t end up holding the position until expiration as they don’t want the money to be tied up, which is why they used a synthetic long stock option call, to begin with.
This type of trade has very little sensitivity to changes in implied volatility as it is short one option and long another.