Synthetic Long Futures (Split Strikes)

The synthetic long futures (split strikes) is a less aggressive version of the synthetic long futures strategy.

The synthetic long futures (split strikes) position is created by buying slightly out-of-the-money calls and selling an equal number of slightly out-of-the-money puts of the same underlying futures and expiration month.

Synthetic Long Futures (Split Strikes) Construction

Buy 1 OTM Call Sell 1 OTM Put

The split strike version of the synthetic long futures strategy offers some downside protection. If the trader's outlook is wrong and the underlying futures price falls slightly, he will not suffer any loss. On the flip side, a stronger upside move is needed to produce a profit.

Profits and losses with a split strike strategy are also not as heavy as a corresponding long futures position as the strategist has traded some potential profits for downside protection.

Unlimited Profit Potential

Similar to a long futures position, there is no maximum profit for the synthetic long futures (split strikes) strategy. The options trader stands to profit as long as the underlying futures price goes up.

The formula for calculating profit is given below:

• Maximum Profit = Unlimited
• Profit Achieved When Price of Underlying > Strike Price of Long Call - Net Premium Received
• Profit = Price of Underlying - Strike Price of Long Call + Net Premium Received

Unlimited Risk

Like the long futures position, heavy losses can occur for the synthetic long futures (split strikes) if the underlying futures price falls sharply.

Often, a credit is received when establishing this position. Hence, even if the underlying futures price remains unchanged on expiration date, there will still be a profit equal to the initial credit received.

The formula for calculating loss is given below:

• Maximum Loss = Unlimited
• Loss Occurs When Price of Underlying < Strike Price of Short Put - Net Premium Received
• Loss = Strike Price of Short Put - Price of Underlying - Net Premium Received + Commissions Paid

Breakeven Point(s)

The underlier price at which break-even is achieved for the synthetic long futures (split strikes) position can be calculated using the following formula.

• Breakeven Point = Strike Price of Short Put - Net Premium Received OR Strike Price of Long Call + Net Premium Paid

Example

Suppose June Crude Oil futures is trading at $40 and each contract covers 1000 barrels. A trader creates a split-strikes synthetic long futures position by selling a JUN 35 put for $2200 and buying a JUN 45 call for $2000. The net credit taken to enter the trade is $200.

Scenario #1: June Crude Oil futures rise moderately to $45

If June Crude Oil futures rallies to $45 on option expiration date, both the short JUN 35 put and the long JUN 45 call will expire worthless and the trader gets to keep the initial credit of $200 as profit.

Scenario #2: June Crude Oil futures rallies explosively to $60

If June Crude Oil futures skyrockets to $60 on option expiration date, the short JUN 35 put will expire worthless but the long JUN 45 call will expire in the money and has an intrinsic value of $15000. Including the initial credit of $200, the options trader's profit comes to $15200. Comparatively, a corresponding long futures position would have achieved a higher profit of $20000.

Scenario #3: June Crude Oil futures crashes to $20

If the price of June Crude Oil futures has instead nosedived to $20, the long JUN 45 call will expire worthless while the short JUN 35 put will expire in the money and be worth $15000. Buying back this short put will require $15000 and subtracting the initial $200 credit received when entering the trade, the trader's loss comes to $14800. A heavier loss of $20000 loss would have been suffered by a corresponding long futures position.

Synthetic Long Futures

There is a more aggressive version of this strategy where both the call and put options involved are at-the-money. While a smaller upside movement of the underlying futures price is required to accrue large profits, this alternative strategy provides less margin for error.

You May Also Like

Continue Reading...

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time.....[Read on...]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®.... [Read on...]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]

Follow Us on Facebook to Get Daily Strategies & Tips!

Futures Basics

Futures Options

Energy Options

Metal Options

Grains Options

Softs Options

Livestock Options

Options Strategy Finder

Outlook on Underlying:
Arbitrage Bearish Bullish Neutral - Bearish on Volatility Neutral - Bullish on Volatility

Profit Potential:
Limited Unlimited

Loss Potential:
Limited Unlimited

Credit/Debit:
Credit Debit

No. Legs:
1 2 3 4