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A Synthetic Put option strategy can be developed by combining stock or futures with options, just like a Synthetic Call option strategy. Hedging against future stock price increases is the aim.
This strategy is referred to as a "synthetic" put since the reward structure is similar to that of a long put. Other names for it include a protective call and a married call. Continue reading to find out more about the synthetic put approach.
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When to Use a Synthetic Put?
Instead of being a technique for creating money, a synthetic put is mostly employed to protect cash. If the underlying stock moves in the desired direction, the strategy's profitability may be lowered due to the call option's inherent cost, or option premium.
Generally speaking, synthetic puts are employed to protect against sudden increases in stock price or to prevent brief price spikes in a generally bearish stock.
By limiting possible losses, synthetic puts give newbies a safety cushion that can boost their confidence as they experiment with various investment approaches. It's crucial to remember that every type of protection comes with a price, which could include commissions, other fees, and the option's purchase price.
Things to Consider Before Using a Synthetic Put Strategy
The objective of a synthetic put strategy is to mitigate risks by modifying via altering the trade structure. Rather than buying or selling more stock, investors can use synthetic options to adjust their positions in the event of an unforeseen change in market. This adaptability reduces capital needs and trading expenses. It's crucial to remember that although this tactic protects against losses, it also reduces the maximum possible return from the first trade. Before putting a synthetic viewpoint into practice, thoroughly consider the benefits and pitfalls.
Benefits of Using a Synthetic Put Strategy
There are various benefits to using synthetic puts in your trading strategy.
- Hedge Against Shares: This tactic shields your investment in the event that the price of the underlying stock suddenly rises.
- Trade Adjustment Flexibility: You don't have to give up your original short position in order to change your market outlook.
- Reduced Transaction Cost: You can save down on trading fees and costs because it takes fewer trades to change your position.
Drawbacks of Synthetic Call Strategy
The synthetic call strategy has the following disadvantages:
- Limitations on Profit Potential: The maximum profit is limited to the difference between the strike price of the put option and the market price of the stock.
- Assignment Risks: The investor may have to take possession of the stock, which could result in losses, if the price of the stock falls below the strike price of the put option.
- Time Decay Effect: Over time, the put option's value decreases, potentially lowering total returns.
Why To Create a Synthetic Put Options
An insurance cover for a short future position is the main function of a synthetic put option.
In the event of a short burst, which could result in a margin call or a temporary mark-to-market (MTM) loss, the trader maintains his short position and employs the call option to keep it intact.
Purchasing a call option, however, has an additional benefit for an open short position on the
same underlying.
The benefit of collateral is the release of funds. Purchasing insurance for a short-term position limits the trade's risk. The exchange releases the margin from the future trade because the risk is capped, allowing the trader to use the released funds to make another trade.
Use the margin calculator to see how much margin is needed to create a short Nifty Future transaction.
To give a short position insurance, a synthetic put strategy is developed. The release of capital, which the trader can utilize to open more positions or make any other transaction while the Synthetic Put is in effect, is a collateral benefit of opening the position.
Conclusion
The synthetic put strategy is useful for traders looking to hedge against unexpected price increases while maintaining a short position. While it offers protection against sharp price movements, traders should consider the associated costs, such as option premiums and brokerage fees. Understanding the mechanics and potential outcomes of the synthetic put strategy can help investors make more informed decisions and manage risks effectively.
