The long put synthetic straddle recreates the long straddle strategy by buying the underlying stock and buying enough at-the-money puts to cover twice the number of shares purchased. That is, for every 100 shares bought, 2 put contracts must be bought.
Buy 2 ATM Puts, Long 100 Underlying
Long put 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 future.
Unlimited Profit Potential
Large gains are made with the long put syntethic straddle when the underlying asset price makes a sizable move either upwards or downwards at expiration.
Unlimited
Profit achieved when: Price of Underlying > Purchase Price of Underlying + Net Premium Paid OR Price of Underlying < Strike Price of Long Put - Net Premium Paid
Profit = Price of Underlying - Purchase Price of Underlying - Net Premium Paid OR Strike Price of Long Put - Price of Underlying - Net Premium Paid
Limited Risk
Maximum loss for the long put synthetic straddle occurs when the underlying asset price on expiration date is trading at the strike price of the put options purchased. At this price, both options expire worthless, while the long 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 Put
Breakeven points
Purchase Price of Underlying + Net Premium Paid
Strike Price of Long Put - Net Premium Paid
Example
Suppose XYZ stock is trading at $40 in June. An options trader executes a long put synthetic straddle by buying two JUL 40 puts for $200 each and buying 100 shares of XYZ stock for $4000. The net premium paid for the puts is $400.
If XYZ stock plunges to $30 on expiration in July, the two JUL 40 puts expire in-the-money and has an intrinsic value of $1000 each. Selling the put options will net the trader $2000. However, the long stock position suffers a loss of $1000. Subtracting the initial premium paid of $400, the long put synthetic straddle's profit comes to $600.
On expiration in July, if XYZ stock is still trading at $40, both the JUL 40 put options expire worthless while the long stock position broke even. Hence, the long put synthetic straddle suffers a maximum loss which is equal to the initial net premium paid of $400 taken to enter the trade.
Long Call Synthetic Straddle
The synthetic straddle can also be implemented using calls instead of puts and that strategy is known as the long call 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 Put Synthetic Straddle
Since the long straddle can be synthetically constructed, similarly, the short straddle can be reconstructed using the short put synthetic straddle strategy. Short put synthetic straddles are utlized when the underlying asset price is perceived to be non-volatile.