What Is a Synthetic Put?
Let me explain what a synthetic put is. It's an options strategy where you combine a short position in a stock with a long call option on that same stock to mimic the effects of a long put option. You might also hear it called a synthetic long put. If you have a short position in a stock, you buy an at-the-money call option on it to protect yourself from any appreciation in the stock's price. This is also known as a married call or protective call.
Key Takeaways
Here's what you need to know right away. A synthetic put involves a short stock position paired with a long call option to replicate a long put. You use it when you're bearish on a stock but worried about potential near-term gains. The goal is to profit from the stock's expected decline, which is why it's often termed a synthetic long put.
Understanding Synthetic Puts
You should understand that a synthetic put is a strategy for when you have a bearish view on a stock but are concerned about short-term upward movements. It's like an insurance policy, but you're hoping the stock price falls, not rises. You short sell the security and add a long call on the same one.
This approach mitigates the risk of the underlying price increasing, but it doesn't cover other risks, leaving you exposed in those areas. Since it includes a short position, you're dealing with fees, margin interest, and possibly paying dividends to the lender of the shares.
Institutional investors might use synthetic puts to hide their trading bias on securities, whether bullish or bearish. For most of you, though, it's best as an insurance policy. Higher volatility helps this strategy, but time decay hurts it.
The maximum profit for a short position or synthetic put is if the stock drops to zero. Remember, you have to weigh any benefits against the options premium.
Imagine a diagram showing the synthetic put structure—it's like a visual of short stock plus long call equaling a long put. The strategy caps the stock price for you, limiting upside risk on your short position.
Your risk in a synthetic put is limited to the difference between the short sale price and the option's strike price, plus commissions. If you shorted at the strike price, your loss is just the premium paid.
Profit, Loss, and Breakeven Formulas
- Maximum Gain = Short sale price - Lowest stock price (ZERO) - Premiums
- Maximum Loss = Short sale price - Long call strike price - Premiums
- Breakeven Point = Short sale price - Premiums
When to Use a Synthetic Put
You should consider a synthetic put more as a way to preserve capital than to make profits. The call option's premium is a built-in cost that reduces your profitability if the stock moves down as expected.
Often, you use synthetic puts as insurance against short-term spikes in an otherwise bearish stock or to protect against unexpected upward moves.
If you're a newer investor, knowing your stock market losses are limited can build your confidence as you learn strategies. But remember, this protection costs you—the option price, commissions, and other fees.
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