Synthetic Short Stock – The Option Strategy Desk Reference

Synthetic Short Stock

Strategy: Buy n ATM or Slightly OTM Puts, 56 DTE

Sell n ATM or Slightly OTM Calls, Same Expiry

Example:

Price Chart: Downtrending

Current IV%: 20%

IV Rank: 30

Trade: Buy one or more ATM or slightly OTM put options; sell an equal number of ATM or slightly OTM call options.

Typical Strike Deltas:

ATM Long Puts 0.50

ATM Short Calls 0.50

Goals: Buy one or more put options on an underlying security that is trending downward. Sell a call option to finance the premium paid for the long call option. Provide ample time for the long puts to move ITM for a corresponding increase in premium value. While the premium of the long put options increases in value, the premium of the short call options decreases in value or additional profit.

Manage: When the long put and short call options return an acceptable profit, and before Theta begins to erode the premium value of the long puts, close the long puts for profit. If the short calls are far OTM, they may either be sold for much less premium than originally received or permitted to expire worthless. If the long put is ITM by several strikes, determine if exercising the option (receiving the intrinsic value less the remaining extrinsic value) is more profitable than simply selling the long put options for the current premium value.

Profit: Close when this trade returns a profit greater than 50 percent; longer-term expirations can return profits well in excess of 100 percent.

Loss: Close this trade to prevent a major loss if the price of the underlying reverses direction as a result of favorable earnings, a new product announcement, or an unexpected positive corporate or financial sector event.