Friday, August 29, 2014
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Long Put Synthetic Straddle

long synthetic straddle (put & call)

long put synthetic straddle

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.
 
long put synthetic straddle construction
buy 2 at the money puts
long 100 shares

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.



long-put-synthetic-straddle

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.

the formula for calculating profit is given below:
  • maximum profit = unlimited
  • profit achieved when price of underlying > purchase price of underlying + net premium paid or price of underlying + commissions & fees 
  • profit = price of underlying - purchase price of underlying - premium paid or strike price of long put - price of underlying - premium paid -commissions & fees

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.

the formula for calculating maximum loss is given below:
  • max loss = net premium paid+ commissions & fees
  • max loss occurs when price of underlying = strike price of long put

breakeven point(s)

there are 2 break-even points for the long put synthetic straddle position. the breakeven points can be calculated using the following formulae.
  • upper breakeven point = purchase price of underlying + premium paid + commissions & fees
  • lower breakeven point = strike price of long put - premium paid - commissions & fees

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.

commissions

for ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts and varies across option brokerages.

long call synthetic straddle

the long call synthetic straddle recreates the long straddle  strategy by shorting the underlying stock and buying enough  at-the-money calls to cover twice the number of shares shorted. that is, for every 100 shares shorted, 2 calls must be bought.

long call synthetic straddle construction
buy 2 at the money calls
short 100 shares


long call 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 term.

unlimited profit potential

large gains are made with the long call synthetic straddle when the underlying asset price makes a sizable move either upwards or downwards at expiration.

the formula for calculating profit is given below:
  • maximum profit = unlimited
  • profit achieved when price of underlying > strike price of long call + net premium paid or price of underlying
  • profit = price of underlying - strike price of long call - net premium paid or sale price of underlying - price of underlying - net premium paid

limited risk

maximum loss for the long call syntethic straddle occurs when the underlying asset price on expiration date is trading at the strike price of the call options purchased. at this price, both options expire worthless, while the short stock position achieved breakeven. hence, a maximum loss equals to the net premium paid is incurred by the options trader.

the formula for calculating maximum loss is given below:
  • max loss = net premium paid + commissions & fees
  • max loss occurs when price of underlying = strike price of long call

breakeven point(s)

there are 2 break-even points for the long call synthetic straddle position. the breakeven points can be calculated using the following formulae.
  •   upper breakeven point = strike price of long call + premium paid + commissions & fees
  •   lower breakeven point = sale price of underlying - premium paid - commissions & fees

example

suppose xyz stock is trading at $40 in june. an options trader enters a long call synthetic straddle by buying two jul 40 calls for $200 each and shorting 100 shares for $4000. the net premium paid for the calls is $400.

if xyz stock is trading at $50 on expiration in july, the two jul 40 calls expire in-the-money and has an intrinsic value of $1000 each. selling the call options will net the trader $2000. however, the short stock position suffers a loss of $1000. subtracting the initial debit of $400, the long call synthetic straddle trader's profit comes to $600.

on expiration in july, if xyz stock is still trading at $40, both the jul 40 calls expire worthless while the short stock position broke even. hence, the long call synthetic straddle trader suffers a maximum loss which is equal to the initial net premium paid of $400 taken to enter the trade.

commissions

for ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts and varies across option brokerages.

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