Thursday, 18 April 2013

Synthetic Short Call - Bearish Strategy

SYNTHETIC SHORT CALL


Synthetic Short Call is a combination of buying a put and selling a call, It is similar to short sale of the underlying stock or index. If the underlying stock or Index declines, the value of the put increases, and the option investor of the Short Synthetic call will profit, similar to someone shorting the stock. If the stock instead advances option trader is at risk on the short call. This Strategy is used when the investor is bearish on the market direction and expects market to fall down in the near term.

The risk and the reward are unlimited in synthetic short call

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

Risk: Unlimited.

Reward: Unlimited.

Breakeven: Strike Price of Put option + net premium received


Illustration

 
Synthetic Short Call Payoff Chart

Index
Nifty
Nifty Lot Size
50
Underlying Strike Price
5700
ATM Call Premium
Rs 120    (Call Premium Received)
ATM Put Premium
Rs 100    (Put Premium Paid)
Breakeven Point
5720 (Nifty Strike Price + Net Premium Received)







Reward Potential

Ø  Maximum Profit = Unlimited
Ø  Profit Achieved When Nifty Settlement Price < Strike Price of Put option + Net Premium Received
Ø  Profit = Strike Price of Long Put – Settlement Price of Nifty + Net Premium Received
Risk Potential               
Ø  Maximum Loss = Unlimited
Ø  Loss Occurs When Settlement Price of nifty > Strike Price of Call option i.e 5700 + Net Premium Received i.e. Rs 20
Ø  Loss = Nifty Settlement Price - Strike Price of Call Option - Net Premium Received + (Brokerage + Statutory Charges)

Nifty Closing Price @
Profit/Loss
5500
  9000 (Profit)
5600
  4000 (Profit)
5700
  1000 (Profit)
5800
  4000 (Loss)
5900
  9000 (Loss)


Let us assume Nifty is trading at 5716 in May 2013.An options trader setups a synthetic short stock combo by buying a Nifty May 2013 5700 put for Rs 100 and sells  a Nifty 5700 May 2013 call for Rs 120. The net credit taken to enter the trade is Rs 20.

If Nifty at the day of expiry rallies to 5800 on expiration in May'13, the Nifty 5700 put purchased at Rs 100 will expire worthless but the Short Nifty 5700 Call sold at Rs 120 expires in the money and has an intrinsic value of Rs 100. Option Trades loss will be (Call Option Premium Received i.e 120 - Put Option Premium Paid i.e Rs 100 - Intrinsic Value Rs100) = Rs 80 X 50 Lot Size resulting in overall loss of Rs 4000

If Nifty at the day of expiry Slides to 5600 on expiration in May'13, the Nifty 5700 Call Sold at Rs 120 will expire worthless but the Short Nifty 5700 Put purchased at Rs 100 expires in the money and has an intrinsic value of Rs 100. Option Trades loss will be (Call Option Premium Received i.e 120 - Put Option Premium Paid i.e Rs 100 - Intrinsic Value Rs 100 ) = Rs 80 X 50 Lot Size resulting in overall loss of Rs 4000