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Synthetic Short Stock creates an option position that can give dollar gains or losses equivalent to shorting stock, but with vastly increased leverage.

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Strategy: Synthetic Short Stock

Synthetic Short Stock Option Graph

The Outlook: Bearish.

The Trade: Buy put and sell call at same strike price. If you use a strike above the current stock price, it will be a debit entry. If you use a strike below the current stock price, it will be a credit entry.

Gains when: Stock falls.

Maximum Gain: Limited only by stock falling to zero.

Loses when: Stock rises.

Maximum Loss : Unlimited

Breakeven Calculation: Usually very close to stock price at the time of entry.

Advantages compared to short stock: Tremendously increased leverage, much less capital required.

Disadvantages compared to short stock: Tremendously increased leverage works to the upside (against the position) as well, limited life.

Volatility: no effect.

Time: no effect.

Margin Requirement : The short call is considered "naked" and the minimum margin would be 10% of the strike price of the short call times the number of shares represented, but probably more.

Synthetic Equivalent: Short Stock.

Comments

  • Synthetic Short Stock has the same profit graph as short stock, during the life of the options.
  • The leverage is tremendously increased compared to being short stock. Using the example graph, a $9 credit could turn into $1009 on a ten point drop in the stock, for an "infinite" percentage gain. But, leverage works to the upside as well. The $9 credit could turn into a $999 loss if the stock rose $10.
  • If you try to protect the upside by buying a call at a higher strike, the graph is the same as a Long Put, and you might as well use the Long Put and save commission expense.
  • Just because Synthetic Short Stock exists does not mean you should ever use it instead of real short stock or other bearish option strategies. Real short stock has the distinct advantage of no expiration date. Synthetic Short Stock exposes you to large risk if your timing is anything less than perfect.
  • One possible use for Synthetic Short Stock is if you want to be short a dividend-paying stock during the dividend period. If you short the stock, you will be charged the dividend amount. If you use Synthetic Short Stock, you will not.

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