What are the characteristics of this option strategy?
Synthetic short call positions combine a short stock position with a short put on the same underlying, which produces the same payoff as a plain short call. Traders use it to collect a put premium on top of a short stock position they already hold. Both legs are short exposure, so this adds risk rather than managing it. The gain is capped at the put premium plus the difference between the short sale price and the strike, while the loss is unlimited if the stock rallies.
Is this a bullish, bearish or neutral strategy?
The Synthetic Short Call Option Strategy is a neutral to bearish strategy. It profits when the stock falls or stays flat and loses without limit when the stock rallies, so it is not suitable in a rising market and is not a risk-reduction tool.
Is this a beginner or an advanced option strategy?
The Synthetic Short Call Option Strategy is considered an advanced option strategy. It involves sophisticated theoretical concepts and advanced investment techniques. Therefore, investors should understand the basics of options trading before attempting to implement this strategy.
In what situation will I use this strategy?
The Synthetic Short Call Option Strategy is typically used when investors believe the stock price will remain relatively unchanged or drift lower. In this situation, the investor sells a put option against a short stock position to collect premium. It does not reduce the risk of the short stock leg. Above the put strike the position loses one for one with the shares, the same as the short stock alone, less the premium received.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The Synthetic Short Call Option Strategy typically falls somewhere in the middle of the risk-reward and probability of profit range. The strategy carries the same risk and reward as a naked short call: unlimited loss on a rally, and a maximum gain of the put premium plus the difference between the short sale price and the put strike. The short put is not protective, it is a second short position.
How is this strategy affected by the greeks?
Since the Synthetic Short Call Option Strategy involves both shorting stock and selling a put, the strategy is affected by all four greeks: delta, gamma, vega, and theta. Delta measures the effect of the underlying stock price on the option position, gamma measures the rate of change of delta with respect to the underlying stock price, vega measures the sensitivity of the option price to volatility, and theta measures the time decay of the option position.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The Synthetic Short Call Option Strategy is typically opened when the VIX level is high. When volatility is high, put premiums are richer, so the credit collected for the short put is larger and the upside breakeven sits further away. A larger credit does not cap the loss: a rally still costs the position without limit, and high volatility is exactly the regime in which such a rally is most likely.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
Adjusting the Synthetic Short Call Option Strategy when the trade moves against you can be easy or difficult, depending on the specific parameters of the position. The easiest way to adjust the position is to close it out and reestablish the position with new parameters. The difficulty in adjusting the position will depend on the current market conditions, the price of the underlying stock, the strike prices of the options, and other factors.
Where does this strategy typically fall in the range of commissions and fees?
The Synthetic Short Call Option Strategy typically falls in the higher end of the range of commissions and fees, due to the fact that it involves two trades (shorting a stock and selling a put). The position is opened for a net credit rather than a debit, but that credit is payment for open-ended risk, not a saving. Shorting the stock also carries borrow costs and a margin requirement that can be raised while the position is open.
Is this a good option income strategy?
The Synthetic Short Call Option Strategy can be a good option income strategy for investors who are looking for ways to generate income from their portfolio. By selling a put option against a short stock position, investors generate income from the put premium. Note that the position already profits when the stock falls, and it is a rise in the stock, not a fall, that produces losses, without limit.
How do I know when to exit this strategy?
The best way to know when to exit the Synthetic Short Call Option Strategy is to determine your risk tolerance and set a stop loss level at a price point where a loss on the position would be acceptable. Additionally, investors should analyze their portfolio on a regular basis to ensure that their positions are still within their desired risk strategies.
How will market makers respond to this trade being opened?
Market makers typically view the Synthetic Short Call Option Strategy as an advantageous trade, as it allows them to potentially collect premiums. Therefore, they are likely to respond positively to the trade being opened.
What is an example (with calculations) of this strategy?
For example, an investor shorts 100 shares of XYZ at $150. The stock dips to $100 and he expects a near term bounce while still looking for a further decline over the longer run, so he sells one $110 strike put for $12. The position now pays off exactly like a short $110 call. If XYZ finishes at or below $110 the put is assigned, the shares bought at $110 close out the short, and he keeps $52 per share: the $40 gain on the shares plus the $12 premium. Above $110 the put stops helping and the short shares keep losing, so the position breaks even at $162 and loses without limit above that. Selling the put is not a hedge for the short stock; it is a second short position on the same name.
MarketXLS is a stock analysis and trading tool that can help make the Synthetic Short Call Option Strategy easier to implement. MarketXLS provides investors with real-time stock data, stock-level analytics, and access to a wide range of options expiration analysis tools. This makes it easier for investors to set up and monitor their Synthetic Short Call Option Strategies quickly and effectively.
Here are some templates that you can use to create your own models
Synthetic Short Straddle with Calls
Conversion Strategy
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
Overview of Synthetic Strangle Investing
Conversion Arbitrage Options Strategy
Short Call Synthetic Straddle Options Strategy (Using MarketXLS Template)
Collar Option Strategy – A Synopsis
Collar Option Strategy – A Synopsis