The Synthetic Short Stock (Split Strikes) is a less aggressive version of the Synthetic Short Stock strategy.
The Synthetic Short Stock (Split Strikes) position is created by selling slightly out-of-the-money calls and buying an equal number of slightly out-of-the-money puts of the same underlying stock and expiration date.
Buy 1 put at the put strike price; Sell 1 call at the call strike price. Use the same expiration date.
The split strike version of the Synthetic Short Stock strategy offers some upside protection. If the trader's outlook is wrong and the underlying stock price rises slightly, he will not suffer any loss. On the flip side, a stronger downward move is necessary to produce a profit.
Profits and losses with a split strike strategy are also not as heavy as a corresponding short stock position as the strategist has traded some potential profits for upside protection.
Profit potential
Similar to a short stock position, there is no limit to the maximum possible profit for the Synthetic Short Stock (Split Strikes). The options trader stands to profit as long as the underlying stock price goes down.
Put strike price minus net opening cost.
Unlimited Risk
Like the short stock position, heavy losses can occur for the Synthetic Short Stock (Split Strikes) if the underlying stock price makes a sharp move upwards.
Often, a credit is usually taken when establishing this position. Hence, even if the underlying stock price remains unchanged on expiration date, there will still be a profit equal to the initial credit taken.
Unlimited as the stock price rises.
Breakeven Point(s)
The breakeven can change depending on which strikes the stock finishes between.
Calculate the breakeven prices
- Put strike price minus net opening cost. Use this result only if it is at or below the put strike price.
- Prices between the put strike price and the call strike price all break even only when the net opening cost equals zero.
- Call strike price minus net opening cost. Use this result only if it is at or above the call strike price.
Ignore results below zero. A boundary price listed twice is a single breakeven.
Example
Suppose XYZ stock is trading at $40 in June. An options trader setups a split-strikes Synthetic Short Stock by buying a JUL 35 put for $50 and selling a JUL 45 call for $100. The net credit taken to enter the trade is $50.
Scenario #1: XYZ stock price falls slightly to $35
If the price of XYZ stock drops to $35 on expiration date, both the long JUL 35 put and the short JUL 45 call will expire worthless and the trader keeps the initial credit of $50 as profit.
Scenario #2: XYZ stock rallies explosive to $60
If XYZ stock rallies and is trading at $60 on expiration in July, the long JUL 35 put will expire worthless but the short JUL 45 call expires in the money and has an intrinsic value of $1500. Buying back this short call will require $1500 and subtracting the initial $50 credit taken when entering the trade, the trader's loss comes to $1450. A heavier loss of $2000 loss would have been suffered by a corresponding short stock position.
Scenario #3: XYZ stock price falls to $20
On expiration in July, if the price of XYZ stock has instead crashed to $20, the short JUL 45 call will expire worthless while the long JUL 35 put will expire in the money and be worth $1500. Including the initial credit of $50, the options trader's profit comes to $1550. Comparatively, a corresponding short stock position would have achieved a greater profit of $2000.
Commissions
For ease of understanding, these examples exclude commissions, fees and financing costs. Include all costs when comparing an actual position; there is no universal commission amount.
For active traders, transaction costs can consume a significant part of returns. Compare the full commission and fee schedule, exercise and assignment charges, and bid-ask spreads. The cost of entering and closing every leg matters.
Synthetic Short Stock
There is a more aggressive version of this strategy where both the call and put options involved are at-the-money. While a smaller downside movement of the underlying stock price is required to accrue large profits, this alternative strategy provides less room for error.
Before expiration and assignment
The diagrams and worked outcomes describe expiration payoffs, not an option’s market price before expiration. Time decay, implied volatility, rates, dividends and bid-ask spreads affect early closing values. American-style short options can be assigned early; a protective long option is not automatically exercised when a short leg is assigned. Closing or exercising one leg can change the remaining position’s risk.
Net opening cost means everything paid to open the position, less everything received. Include the shares as well as the options. If opening the position brings in money overall, treat that cost as a negative amount.
Amounts are per share before fees. Multiply by the shares covered by the position; standard equity options usually cover 100 shares per contract. If a maximum profit or loss calculation gives a negative amount, use zero. These figures assume matching contracts held to expiration and do not include financing or early assignment.
