Option trading long put and call vs
The capital outlay for buying the puts is recouped through writing the calls. If the stock fell in price, then you would gain through the purchased puts, but if it increased in price, then you would lose from the written calls. The potential profits and the potential losses are roughly equal to what they would be if you were short selling the stock. There are two main advantages here.
The primary advantage is again leverage, while the second advantage is related to dividends. If you have short sold stock and that stock returns a dividend to shareholders, then you are liable to pay that dividend. With a synthetic short stock position you don't have the same obligation. A synthetic long call is created by buying put options and buying the relevant underlying stock. This combination of owning stocks and put options based on that stock is effectively the equivalent of owning call options.
A synthetic long call would typically be used if you owned put options and were expecting the underlying stock to fall in price, but your expectations changed and you felt the stock would increase in price instead.
Rather than selling your put options and then buying call options, you would simply recreate the payoff characteristics by buying the underlying stock and creating the synthetic long call position. This would mean lower transaction costs. A synthetic short call involves writing puts and short selling the relevant underlying stock.
The combination of these two positions effectively recreates the characteristics of a short call options position. It would usually be used if you were short on puts when expecting the underlying stock to rise in price and then had reason to believe the stock would actually fall in price.
Instead of closing your short put options position and then shorting calls, you could recreate being short on calls by short selling the underlying stock. Again, this means lower transaction costs. A synthetic long put is also typically used when you were expecting the underlying security to rise, and then your expectations change and you anticipate a fall. If you had bought call options on stock that you were expecting to rise, you could simply short sell that stock.
The combination of being long on calls and short on stocks is roughly the same as holding puts on the stock — i. When you already own calls, creating a long put position would involve selling those calls and buying puts. By holding on to the calls and shorting the stock instead, you are making fewer transactions and therefore saving costs.
A normal short put position is usually used when you are expecting the price of an underlying stock increase by moderate amount.
The synthetic short put position would generally be used when you had previously been expecting the opposite to happen i. If you were holding a short call position and wanted to switch to a short put position, you would have to close your existing position and then write new puts.
However, you could create a synthetic short put instead and simply buy the underlying stock. A combination of owning stock and having a short call position on that stock essentially has the same potential for profit and loss as being short on puts. Understanding Synthetic Positions The basic definition of synthetic positions is that they are trading positions created to emulate the characteristics of another position.
Why use Synthetic Positions? Section Contents Quick Links. Why Use Synthetic Positions? Synthetic Long Stock A synthetic long stock position is where you emulate the potential outcomes of actually owning stock using options.
Synthetic Short Stock The synthetic short stock position is the equivalent of short selling stock, but using only options instead. Synthetic Long Call A synthetic long call is created by buying put options and buying the relevant underlying stock. Synthetic Short Call A synthetic short call involves writing puts and short selling the relevant underlying stock. Synthetic Long Put A synthetic long put is also typically used when you were expecting the underlying security to rise, and then your expectations change and you anticipate a fall.
Synthetic Short Put A normal short put position is usually used when you are expecting the price of an underlying stock increase by moderate amount. You can learn more about delta in Meet the Greeks. Try looking for a delta of -. In-the-money options are more expensive because they have intrinsic value, but you get what you pay for. If the stock goes to zero you make the entire strike price minus the cost of the put contract.
For this strategy, time decay is the enemy. It will negatively affect the value of the option you bought. After the strategy is established, you want implied volatility to increase.
Options involve risk and are not suitable for all investors. For more information, please review the Characteristics and Risks of Standardized Options brochure before you begin trading options. Options investors may lose the entire amount of their investment in a relatively short period of time. Multiple leg options strategies involve additional risks , and may result in complex tax treatments.
Please consult a tax professional prior to implementing these strategies. Implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or the probability of reaching a specific price point. The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract.
There is no guarantee that the forecasts of implied volatility or the Greeks will be correct. Ally Invest provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice.
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