Wednesday, 17 April 2013

Synthetic Long Futures - Bullish Strategy

Synthetic Long Futures

Long Synthetic Futures is a strategy to be used when the investor is bullish on the market direction.
The investor buys an at-the-money call option and sells an at-the-money put option for the same amount of the underlying security, and is able to profit from an upward price movement.
Long Synthetic is a a position which is long (Nifty Apr Call Option Strike Price 5700) and short (Nifty Apr Put Option Strike Price 5700) will always result in purchasing the underlying asset for 5700 at exercise or expiration. If Nifty Futures is above 5700, the call is in the money and will be exercised; if Nifty Futures is below 5700 then the short put position will be assigned, resulting in a (forced) purchase of the underlying at 5700.

Long Synthetic behaves exactly the same as being long on the underlying security.It has the benefit of being much cheaper than buying the underlying outright.
Investor View: Bullish on direction of the Stock / Index.

Risk: Unlimited.

Reward: Unlimited.

Breakeven: Nifty Strike Price +/- net premium paid or received.


Illustration


Synthetic Long Futures



Index
Nifty
Nifty Lot Size
50
Underlying Strike Price
5700
ATM Call Premium
Rs 60    (Call Premium Paid)
ATM Put Premium
Rs 45    (Put Premium Received)
Breakeven Point
5715 (Nifty Strike Price + Net Premium Paid)




Reward Potential

Ø  Maximum Profit = Unlimited
Ø  Profit Achieved When Settlement Price of Nifty > Strike Price of call Option + Net Premium Paid (Rs 60 Call option – Rs 45 Put option)
Ø  Profit = Settlement Price of Nifty – Strike Price of Call Option - Premium Paid

Risk Potential
                                               
Ø  Max Loss = Unlimited
Ø  Loss occurs= When Settlement Price of Nifty < Strike Price of Put Option i.e 5700 + Net Premium Paid i.e Rs 15
Ø  Loss = Strike Price of Put Option – Nifty Settlement Price + Net Premium Paid

Nifty Closing Price @
Profit/Loss
5500
10750 (Loss)
5600
  5750 (Loss)
5700
    750 (Loss)
5800
  4250 (Profit)
5900
  9250 (Profit)






Example 1 : Nifty @ 5800

Let us assume Nifty is trading at 5800 on Expiry date,
Call Option will remain in the money and have an intrinsic value of Rs 5000 ((Nifty Settlement Value i.e 5800 – Nifty Call Option Strike Price i.e. 5700) X 50 Lot Size) reducing the premium paid of Rs 60 for call option.

Overall Profit for Long Call Option would be Rs 2000/- (Rs 5000 (Intrinsic Value)- Rs 3000 (Call option premium paid)

Nifty Apr 5700 Put option sold at Rs 45 is out of the money and expires worthless resulting in overall gain of Rs 2250/- (45 X 50 Lot Size)
Total gain is Rs 2000 + Rs 2250 = Rs 4250

Example 2 : Nifty @ 5600

Let us assume Nifty is trading at 5600 on Expiry date,
Put Option will remain in the money and have an intrinsic value of Rs 5000 ((Nifty Put Option Strike Price i.e. 5700 - Nifty Settlement Value i.e 5600 –) X 50 Lot Size) reducing the premium received of Rs 45 for put option.

Overall loss for Short Put Option is Rs 2750/- (Rs 5000 (Intrinsic Value)- Rs 2250 (Put option premium received)

Nifty Apr 5700 Call option purchased at Rs 60 is out of the money and expires worthless resulting in overall loss of Rs 3000/- (60 X 50 Lot Size)
Total Loss is Rs 2750 + Rs 3000 = Rs 5750