OPTION SYNTHETIC LONG CALL STRATEGY : BUY STOCK, BUY PUT
OPTION SYNTHETIC LONG CALL STRATEGY : BUY STOCK, BUY PUT
In this strategy, we purchase a stock since we feel bullish about it. But what if the price of the stock went down. You wish you had some insurance against the price fall. So buy a Put on the stock. This gives you the right to sell the stock at a certain price which is the strike price. The strike price can be the price at which you bought the stock (ATM strike price) or slightly below (OTM strike price).
In case the price of the stock rises you get the full benefit of the price rise. In case the price of the stock falls, exercise the Put Option (remember Put is a right to sell). You have capped your loss in this manner because the Put option stops your further losses. It is a strategy with a limited loss and (after subtracting the Put premium) unlimited profit (from the stock price rise). The result of this strategy looks like a Call Option Buy strategy and therefore is called a Synthetic Call!
But the strategy is not Buy Call Option (Strategy 1). Here you have taken an exposure to an underlying stock with the aim of holding it and reaping the benefits of price rise, dividends, bonus rights etc. and at the same time insuring against an adverse price movement.
In simple buying of a Call Option, there is no underlying position in the stock but is entered into only to take advantage of price movement in the underlying stock.
When to use: When ownership is desired of stock yet investor is concerned about near-term downside risk. The outlook is conservatively bullish.
Risk: Losses limited to Stock price + Put Premium – Put Strike price
Reward: Profit potential is unlimited.
Break-even Point: Put Strike Price + Put Premium + Stock Price – Put Strike Price
Example
Mr. XYZ is bullish about ABC Ltd stock. He buys ABC Ltd. at current market price of Rs. 4000 on 4th July. To protect against fall in the price of ABC Ltd. (his risk), he buys an ABC Ltd. Put option with a strike price Rs. 3900 (OTM) at a premium of Rs. 143.80 expiring on 31st July.
| Strategy : Buy Stock + Buy Put Option |
| Buy Stock (Mr. XYZ pays) |
Current Market Price of ABC Ltd. (Rs.) |
4000 |
| Strike Price (Rs.) | 3900 | |
| Buy Put (Mr. XYZ pays) | Premium (Rs.) | 143.80 |
| Break Even Point (Rs.) (Put Strike Price + Put Premium + Stock Price – Put Strike Price)* |
4143.80 |
recover the cost of the Put Option purchase price + the stock price to break even.
Example :
ABC Ltd. is trading at Rs. 4000 on 4th July.
Buy 100 shares of the Stock at Rs. 4000
Buy 100 July Put Options with a Strike Price of Rs. 3900 at a premium of Rs. 143.80 per put.
ANALYSIS: This is a low risk strategy. This is a strategy which limits the loss in case of fall
in market but the potential profit remains unlimited when the stock price rises. A good
strategy when you buy a stock for medium or long term, with the aim of protecting any
downside risk. The pay-off resembles a Call Option buy and is therefore called as Synthetic
Long Call.
