The long call synthetic straddle recreates the long straddle strategy by shorting the underlying stock and buying enough at-the-money calls to cover twice the number of shares shorted. That is, for every 100 shares shorted, 2 calls must be bought.
Buy 2 ATM Calls, Short 100 Underlying
Long call synthetic straddles are unlimited profit, limited risk options trading strategies that are used when the options trader feels that the underlying asset price will experience significant volatility in the near term.
Unlimited Profit Potential
Large gains are made with the long call synthetic straddle when the underlying asset price makes a sizable move either upwards or downwards at expiration.
Unlimited
Profit achieved when: Price of Underlying > Strike Price of Long Call + Net Premium Paid OR Price of Underlying < Sale Price of Underlying - Net Premium Paid
Profit = Price of Underlying - Strike Price of Long Call - Net Premium Paid OR Sale Price of Underlying - Price of Underlying - Net Premium Paid
Limited Risk
Maximum loss for the long call syntethic straddle occurs when the underlying asset price on expiration date is trading at the strike price of the call options purchased. At this price, both options expire worthless, while the short stock position achieved breakeven. Hence, a maximum loss equals to the net premium paid is incurred by the options trader.
Net Premium Paid + Commissions Paid
Loss occurs when: Price of Underlying = Strike Price of Long Call
Breakeven points
Strike Price of Long Call + Net Premium Paid
Sale Price of Underlying - Net Premium Paid
Example
Suppose XYZ stock is trading at $40 in June. An options trader enters a long call synthetic straddle by buying two JUL 40 calls for $200 each and shorting 100 shares for $4000. The net premium paid for the calls is $400.
If XYZ stock is trading at $50 on expiration in July, the two JUL 40 calls expire in-the-money and has an intrinsic value of $1000 each. Selling the call options will net the trader $2000. However, the short stock position suffers a loss of $1000. Subtracting the initial debit of $400, the long call synthetic straddle trader's profit comes to $600.
On expiration in July, if XYZ stock is still trading at $40, both the JUL 40 calls expire worthless while the short stock position broke even. Hence, the long call synthetic straddle trader suffers a maximum loss which is equal to the initial net premium paid of $400 taken to enter the trade.
Long Put Synthetic Straddle
The synthetic straddle can also be implemented using long puts instead of long calls and that strategy is known as the long put synthetic straddle.
Commissions
These examples exclude commissions and fees. Include all transaction costs when evaluating the profit or loss of a position.
Similar strategies
Short Call Synthetic Straddle
Since the long straddle can be synthetically constructed, likewise, the short straddle can be recreated using the short call synthetic straddle strategy. Short call synthetic straddles are used when the underlying stock price is perceived to be non-volatile.