Option Strategy - Synthetic Long Call

10th October 2011,Monday


Synthetic Long Call: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.

Risk:Losses limited to stock price + Put Premium - Put Srike price