Synthetic Short Call – The Option Strategy Desk Reference

Synthetic Short Call

Strategy: Sell n ATM Puts, 56 DTE

Short n × 100 Shares

Example:

Price Chart: Downtrending

Current IV%: 20%

IV Rank: 30

Trade: Sell n ATM put option contracts; short n × 100 shares of stock.

Typical Strike Delta:

ATM Short Puts 0.50 to 0.45

Goals: The trader expects a price drop in the underlying security, as shown in this trade’s risk profile. As the price drops, the stock initially achieves 2× the premium value lost by the short put options. This difference declines as the short put options move further ITM where the put strikes’ Delta values become higher. If the price experiences an unwanted rally, the short puts provide a hedge against the loss in stock value. Recall how a hedge offsets only a portion of a potential loss. As with the synthetic long put options, the 0.50 Delta value of the ATM short puts is one-half the Delta 1.0 value of the stock.

Manage: When the short stock drops in value by several dollars per share, the trader may decide to sell it for profit and buy to close the short puts to cut off further loss in premium value and to prevent being assigned. If the stock experiences an unexpected (and unwanted) price rally, the trader should buy to cover (close) the short stock trade and keep the short puts as they drop OTM. This offsets a portion of the short stock’s loss. After closing the short stock trade, if the price of the stock continues to rally by several dollars, the short put options may even achieve breakeven or a small profit.

Profit: Close the short stock trade and short put options when the short stock and short puts achieve a combined profit approaching 30 percent. (Note that the short puts will return a loss, while the short stock profits in response to the anticipated price drop.)

Loss: If not carefully managed, this trade can potentially lose 50 percent or even more if the stock rallies without trader intervention.