What are the characteristics of this option strategy?
Synthetic short put positions are built by buying 100 shares and writing one call against them, which produces the same payoff as selling a put. Traders use it to accommodate near term softness in a stock they are bullish on over the longer run. It cushions a decline only by the amount of premium received; it does not limit the downside. Below the strike the position loses value with the stock all the way to zero, so the maximum loss is the price paid for the shares less the premium received.
Is this a bullish, bearish or neutral strategy?
This strategy is a neutral to moderately bullish strategy. Net delta is positive (long 100 shares less the call's delta), so the position gains if the stock is flat or drifts higher and loses if it falls. It reduces the effective cost basis of the shares by the premium collected, but it is not a hedge. Real downside protection requires buying a put (a protective put), or financing that put by also selling a call (a collar).
Is this a beginner or an advanced option strategy?
This strategy is an advanced level strategy. It requires the trader to write call option at the right time and neutralize it at the right time to gain maximum benefits from near term volatility/bearishness
In what situation will I use this strategy?
This strategy is typically used when the investor expects the underlying stock or index to stay flat or pull back modestly in the near term while remaining bullish over the longer run, and wants to earn income from the premium of the call being written in the meantime. It is not used to protect the shares, since the premium offsets a decline only by its own size.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
This strategy typically falls in the middle range in terms of risk-reward and probability of profit. The probability of profit is reasonable, because the premium adds a small cushion to an otherwise ordinary long stock position. The two outcomes are lopsided in size, though: the reward is capped at the strike plus the premium, while the risk is the whole share position less that premium.
How is this strategy affected by the greeks?
This strategy is affected mainly by delta, theta and vega. Net delta stays positive, so the position still gains and loses with the stock; writing the call reduces that sensitivity but does not remove it, and the premium offsets a decline only by its own size. Theta works for the writer as the short call decays, while vega works against the position if implied volatility rises after the call is sold.
In what volatility regime (i.e VIX level) would this strategy be optimal?
This strategy performs best when implied volatility is in the medium to high range, with a VIX level between 20 and 40.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
Adjusting this strategy when the trade goes against you is relatively straightforward and can be done by either buying a call option to cover the existing call option, closing the whole position and taking the loss, or using an option spread. However, this strategy does have a few complexities which can make it difficult for a beginner trader to adjust.
Where does this strategy typically fall in the range of commissions and fees?
This strategy typically falls in the middle range of commissions and fees, as it requires the purchase of the shares and the sale of one call option per 100 shares.
Is this a good option income strategy?
Yes, the Synthetic Short Put Option Strategy is a good option income strategy, as it can be used to generate income. However this strategy is meant for a different purpose. There are many other beginner level strategy that are better in terms of generating income.
How do I know when to exit this strategy?
The best time to exit this strategy is when the investor is satisfied that they have achieved the desired downside, or when the risk/reward ratio no longer makes sense. Generally, it is best to exit this strategy before expiration to maximize the potential gains.
How will market makers respond to this trade being opened?
Market makers will generally respond positively to this trade, as it creates trading opportunities for them.
What is an example (with calculations) of this strategy?
For example, an investor buys 100 shares of XYZ at $100. The stock rises to $150 and he expects a near term pullback but is still bullish long term, so he sells one $150 strike call for $6. The payoff is now identical to a short $150 put: the most he can make is $56 per share (the $50 stock gain plus the $6 premium) if the stock is at or above $150 at expiration, the $6 premium offsets only the first $6 of any pullback, and below $144 he is worse off than if he had simply sold the shares. The position keeps losing below that, to a maximum loss of $94 per share against his $100 cost basis if the stock goes to zero. This way, the investor has replicated a short put.
How can MarketXLS help?
MarketXLS is a comprehensive set of tools for constructing and managing option strategies. It offers a comprehensive range of tools for constructing and managing option strategies, including options pricing and the Greeks, advanced risk-reward analyses, and trade execution. With MarketXLS, you have the tools to maximize your profits and minimize your risks.
Here are some templates that you can use to create your own models
Synthetic Short Straddle with Puts
Conversion Strategy
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
Synthetic Short Straddle With Puts Option Strategy
Overview of Synthetic Strangle Investing
Conversion Arbitrage Options Strategy
Synthetic Long Stock Option Strategy (Explained With Excel Template)
Collar Option Strategy – A Synopsis