Options Education Center

What is a synthetic stock position?

Synthetic long and short stock positions offer traders alternative methods to achieve stock-like exposure using options contracts. They can provide capital efficiency and flexibility while maintaining similar risk-reward profiles to traditional stock positions.

Benefits of trading synthetic long and short stock positions

Synthetic stock positions offer several compelling advantages for sophisticated options traders.

Understanding the risks of synthetic positions

While synthetic long and short stock positions offer attractive benefits, they come with specific risks that traders must understand and manage.

Types of synthetic stock positions

Synthetic long stock

A synthetic long stock position can be used instead of buying stock when expecting an upward price movement in the underlying.

a. Structure

• Buy one near or at-the-money call option.
• Sell a put option with the same strike price and expiration.

b. Profit and risk

• This combination creates a position that mimics owning stock, with the position gaining value as the stock price rises and losing value as it falls.
• When the stock price moves above the strike price, the call option gains value while the short put loses less.
• Below the strike price, the short put loses value while the long call’s losses are limited.
• Maximum profit: Unlimited on upward price movement.
• Maximum risk: Limited from the put’s strike price to zeroplus the premium paid for the call option.

c. Breakeven prices

• Debit position breakeven: Strike price of the long call plus the premium paid.
• Credit position breakeven: Strike price of the long call minus the premium collected.

Trade example: Synthetic long stock position

Xcel Energy (XEL) appeared in the RadarScreen® filter on the Synthetic Long workspace. The stock is in a weekly uptrend and has retraced to a demand area where the price is expected to bounce.

If we buy 100 shares of the stock at $68.75, the cost would be $6,875, not including commissions and fees.

Synthetic long stock

We will build the options position using the 21 March 2025 options with 99 days until expiration to minimize time decay. The current price is between two strikes, so we have a choice to make when creating the position.

First, we can buy the 65 call for $5.20 and sell the 65 put for $1.15. The resulting synthetic long has a cost of $4.05.

The synthetic long stock costs $405 but also requires a margin of about $1,600. This is much lower than the $6,875 needed to buy the stock. For details on margin requirements, visit TradeStation’s Options Margin Requirements.

Breakeven analysis

The breakeven price is $69.05, calculated as the long 65 strike plus the $4.05 premium paid.

Maximum loss

A maximum loss of $6,905 will occur if the underlying stock drops to zero at expiration. This is the 65 strike times 100 shares plus the premium paid.

Profit potential before expiration

The trade does not need to be held until its expiration. If the underlying price moves upward and results in a satisfactory profit, the position could be exited by selling the long in-the-money call and buying to cover the short out-of-the-money put.

Trade management

The position can be closed manually or managed with an activation rule. For example, you can set up an exit order that triggers when a certain profit or loss has been achieved. This approach allows the trade to adapt to market conditions and capitalize on price movement. More information on activation rules can be found in the Options Education Center here: Placing Activation Rules on Options Orders | TradeStation.

The synthetic long stock for a credit

If we expected a significant upward price movement in the underlying stock, we could open the synthetic long stock position using the out-of-the-money 70 strike. The call cost $2.10, and the put sold for $3.10. The resulting synthetic long has a credit of $1.00.

Breakeven analysis

The breakeven price is $69.00, calculated as the long 70 strike minus the 1.00 premium received.

Maximum loss

A maximum loss of $6,900 will occur if the underlying stock drops to zero at expiration. This is the 70 strike times 100 shares minus the premium collected.

Trade management

The position can be closed manually or managed like the debit synthetic.

Synthetic short stock

A synthetic short stock options position replicates short stock exposure, profiting from price declines and losing value in rising markets.

a. Structure

• Buy one near or at-the-money put option.
• Sell a call option with the same strike price and expiration.

b. Profit and risk

• Maximum profit: From breakeven to zero on downward movement.
• Maximum risk: Unlimited on upward movement.

c. Breakeven prices

• Debit position breakeven: Strike price of the long put minus the premium paid.
• Credit position breakeven: Strike price of the long put plus the premium collected.

Trade example: Synthetic short stock position

Enphase Energy Inc. (ENPH) appeared in the RadarScreen filter on the Synthetic Short workspace. The stock is in a weekly downtrend, and the daily price looks ready to drop due to selling pressure.

Shorting 100 shares of stock at the current $73 price level would require $7,300, not including commissions and fees.

Synthetic short stock

We will build the options position using the 21 March 2025 options with 99 days until expiration to minimize the time decay. The current price is between two strikes, but we will use the in-the-money strike to reduce the probability of early assignment.

We can buy the 75 put for $11.05 and sell the 75 call for $9.70. The resulting synthetic short has a cost of $1.35. Including the approximate $2,400 margin needed for the position, the cost of $2,535 is much lower than the $7,300 required to short the stock.

Breakeven analysis

The breakeven price is $73.65, calculated as the long 75 strike minus the $1.35 premium paid.

Maximum loss

The maximum loss is infinite since there is no cap on how high the stock price can go. A stop loss should be applied to mitigate the risk.

Profit potential before expiration

The trade does not need to be held until its expiration. If the underlying price moves downward and results in a satisfactory profit, the position could be exited by selling the long in-the-money put and buying to cover the short out-of-the-money call.

Trade management

The position can be closed manually or managed with an activation rule.

Volatility effect on synthetic stock positions

Monitoring implied volatility

Because synthetics comprise both a long and short option position, Vega is generally very low. As a result, changes in implied volatility should not greatly impact the position.

Conclusion

Technical considerations play a vital role in synthetic position management. Traders must understand initial and maintenance margin requirements, monitor account equity levels, and maintain adequate cash for potential assignment. Tax implications differ from standard stock positions and may involve wash sale considerations, making consultation with tax professionals advisable.

Success with synthetic stock positions requires a thorough understanding of position dynamics, active risk management, and disciplined execution. Traders can practice these strategies in TradeStation’s simulated trading environment. It’s advisable to begin with small positions and scale gradually as the trader gains experience. Each trade should align with clearly defined risk tolerance levels and investment objectives. Through careful implementation and management, synthetic positions can be valuable tools in a comprehensive trading strategy.