Monday, 15 April 2013

Synthetic Long Call

Synthetic Long Call

Synthetic Long Synthetic is a strategy to be used when the option trades is concerned about the near term downside risk

This strategy involves buying a Put Option, while owning shares in the same underlying or Index , it is a strategy with a limited loss and (after subtracting the Put premium) unlimited profit.
Long Synthetic behaves exactly the same as being a long call


Nifty Synthetic Long Call
Buy 1 lot Nifty Futures or Stock
Buy 1 ATM Index Put


Investor View: Bullish on direction of the Stock / Index.

Risk: Limited

Reward: Unlimited.

Higher Breakeven:  Purchase Price or Index/Stock + Put Premium paid + brokerage + Statutory charges

Illustration

Index
Nifty
Nifty Lot Size
50
Nifty Spot Price
5580
Nifty Put Strike Price
5600
Put Premium
Rs 70    (Put Premium Paid)
Breakeven point
Purchase Price of Nifty + Premium Paid



Reward Potential

  • Profit = Unlimited
  • Profit Achieved When Settlement Price of Nifty > Purchase Price of Nifty i.e. 5580 + Put Option Premium i.e.70
  • Maximum Profit = Settlement Price of Nifty – Purchase price of Nifty – Premium Paid
Risk Potential
  •  Max Loss = Put Option Premium Paid + Brokerage(s) + Statutory Charges
  •  Loss occurs= When Settlement Price of Nifty <= Strike Price of Put Purchased i.e 5600

Nifty Closing Price @
Profit/Loss
5400
3500 (Loss)
5500
3500 (Loss)
5600
3500 (Loss)
5700
2500 (Profit)
5800
7500 (Profit)


Example:
Let us assume Nifty is trading at 5500 in Apr 2013. An investor by buy Apr 5500 put for Rs 70/- and a Nifty Apr Futures for Rs 5580. The net premium paid to enter the trade is Rs 2500 ((Put Option Premium) X 50 Lot size), which is also his maximum possible loss.

If Nifty is trading at 5500 on expiration in April, the Apr 5600 put will expires in the money and will possess intrinsic value of Rs 100, Subtracting the premium paid of Rs 70, Put option will yield a profit of Rs 30 but at the same time Futures position would be in a loss of Rs 30 resulting in overall loss of premium paid

On expiration in April, if Nifty is trading at 5700, Put option will expire worthless and futures position would yield a profit of Rs 6000/- (5700 – 5580 X 50 Lot size) reducing the premium paid of Rs 3500 (70 X 50 per lot) , Investor will make a profit of Rs 2500/-

For More Information about other strategies kindly click on below links
Guide To Options Basics
Long Call
Long Put
Short Call 
Short Put
Long Straddle
Short Straddle