Synthetic Call Strategy: All You Need to Know

What are Some Types of Synthetic Options?

Call options, put options, and the underlying asset can be used to replicate option positions for almost any option. Synthetic long stocks, synthetic short stocks, synthetic long calls, synthetic short calls, synthetic long puts, and synthetic short puts are the fundamental types of synthetic positions.  The graphs that follow demonstrate how the underlying asset and its options can be used to build these synthetic positions.

What is a Synthetic Call Strategy?

For traders who are confident in an asset they currently own, like stocks, but wish to protect themselves from sudden drops in value, a synthetic call strategy is perfect. Buying a put option on the owned asset is part of this strategy. The trader gains from the asset's appreciation if the price increases. But, if it declines, the possible loss is capped at the put option premium, lowering overall risk while maintaining the possibility of upside gains.
 

How Does a Synthetic Call Option Strategy Work?

By buying not only call options but also short-selling an equal number of shares at the same point of time, traders can create a synthetic long position using a synthetic call option method. Not only Buying stocks but also buying puts are also covered by this strategy. This method resembles the movement of the underlying asset, but it’s less expensive or risky than directly purchasing the stock.  

When investors wish to make money without really owning the asset and are expecting a price increase, they employ this tactic. This approach offers more flexibility but works similarly to a long call option. By changing their holdings by purchasing or disposing of extra shares or options without completely closing off their initial trade, traders can alter their exposure.  Additionally, it enables them to profit from transient price changes without making a long-term investment.

But even while this tactic aids in risk and expense management, it has drawbacks of its own. To prevent possible traps, traders need to keep enough margin levels and be informed of market conditions.
 

Example of Synthetic Call Strategy

Consider a potential investor who wishes to purchase a share of a stock that is currently trading at ₹200.  The investor hopes to profit from the anticipated increase in the stock price. The investor purchases the stock at ₹200 and simultaneously sells a put option with a strike price of ₹200 and a one-month expiration date in order to implement the synthetic call technique. The investor obtains a premium of ₹5 when they sell the put option. The position created by purchasing the stock and selling the put option resembles the payout of a long call option.
 

Example of Synthetic Call Strategy:

Scenario 1: Stock price rises to ₹300
The investor gains ₹60 per share from the stock price increase.
The put option expires worthless, meaning no additional obligation.
The investor keeps the ₹7 premium, increasing the total profit.

Scenario 2: Stock price remains at ₹250
The put option expires worthless, so there is no impact from it.
The investor still keeps the ₹7 premium as profit.

Scenario 3: Stock price drops to ₹180
The put option is exercised, forcing the investor to buy more shares at ₹250 per share.
Since the investor had already received a ₹7 premium, their effective cost per share is ₹243 instead of ₹250.
This strategy allows investors to benefit from price increases while managing risk with the premium received from the put option. However, if the stock price drops significantly, they must be prepared to buy at the agreed price.
 

Benefits of Synthetic Call Option Strategy:

Synthetic call option is an efficient tactic for investors looking to maximize their investment plan. This approach has a numerous benefits, consisting:

• Minimized Costing of Investment: It offers a more affordable option than buying equities directly.
• Mitigate Risk of Volatility: Reduces the effect of implied volatility changes over time.
• Making a Profit with Price: This allows traders to profit from growing stock prices with a smaller initial outlay of funds.
• Increased Flexibility of Portfolio: Investors don't have to liquidate their positions to change their exposure.
• Managed Risk of Portfolio: Provides lucrative opportunities while assisting in reducing overall portfolio risk.
• Proper trade timing: This gives traders greater control over when their trades are executed.
   

Conclusion

The synthetic call strategy assists investors/traders to make a profit from increasing prices of stock while restricting the risk of downside. This strategy consists of not only buying stock but also selling put options with the same strike price and expiration date as a call option. Prior to using this strategy, investors/traders should calculate not only the potential risks but also the rewards delicately to make sound decisions.