Synthetic Options vs Normal Options

[optionstrader2022]

I am looking at a conversion trade on SPY. If someone were to short the SPY call and long the synthetic, they would have a guaranteed return of about $27.

Where does this difference/premium actually come from? Why is the synthetic call cheaper than the long call by itself?

 

[Robert Morse]

I can't tell from the picture. What is the net price you expect to trade this conversion on the SPY May 17, 2024 525 conversation.

I am looking at a conversion trade on SPY. If someone were to short the SPY call and long the synthetic, they would have a guaranteed return of about $27.

Where does this difference/premium actually come from? Why is the synthetic call cheaper than the long call by itself?

 

[optionstrader2022]

I can't tell from the picture. What is the net price you expect to trade this conversion on the SPY May 17, 2024 525 conversation.

The 525 call will be shorted, the 525 put will be longed, and 100 shares of SPY will be longed for a total debit of 524.73

 

[Robert Morse]

$0.27 profit before commission and regulatory fee per option? what is it after all fees? $0.27 net comes out to about a yearly return of about 3.75% and only for 5 days. Do you consider that good? And if the SPY pins to 525 Friday and you need to close it? And if you need to borrow money at retail rates to put this on, even worse.

 

[optionstrader2022]

I wasn't looking at the conversion to actually trade it but more so to understand why there is a difference in the price of these two legs.

To my understanding, the long call and synthetic version of it are essentially the same thing. If so, why is there a difference in prices between the two of them?

 

[Robert Morse]

Interest. If the Fed Funds were 0%, the discount would be tiny. If Fed Funds were 10%, the difference would be much greater. You also need to take into account dividends, but I do not see any this week.

I wasn't looking at the conversion to actually trade it but more so to understand why there is a difference in the price of these two legs.

To my understanding, the long call and synthetic version of it are essentially the same thing. If so, why is there a difference in prices between the two of them?

 

[optionstrader2022]

Interest. If the Fed Funds were 0%, the discount would be tiny. If Fed Funds were 10%, the difference would be much greater. You also need to take into account dividends, but I do not see any this week.

Thank you, but more specifically, what actually acccounts for the interest?

Is it based on the fact that the person trading the synthetic has to come up with more capital so because of that, the price is discounted for them because of the opportunity cost of the risk free rate? Or is it something else?

 

[Robert Morse]

A better explanation would require too much typing. If this does not work, try and google it or call me tomorrow. if you do this 10 times, it requires $524,730. The profit over 5 days is $270. 270*(365/5) = 19,710. 19,710/524,730 = 0.03756. With those values, if you can do this every 5 days with no fees or pin risk or dividends, the return is about 3.756%. Just that simple.

Thank you, but more specifically, what actually acccounts for the interest?

 

[TheDawn]

I am looking at a conversion trade on SPY. If someone were to short the SPY call and long the synthetic, they would have a guaranteed return of about $27.

Where does this difference/premium actually come from? Why is the synthetic call cheaper than the long call by itself?

Synthetic options are not the same thing as real options. They are called synthetic options because they have the same pattern of profit/loss but they are not the same in that synthetic options when involving underlying assets would enjoy dividends, interests and also have different transaction costs and all of these get priced in.

 

[optionstrader2022]

Synthetic options are not the same thing as real options. They are called synthetic options because they have the same pattern of profit/loss but they are not the same in that synthetic options when involving underlying assets would enjoy dividends, interests and also have different transaction costs and all of these get priced in.

Thanks! In this SPY example, what makes the long option more expensive relative to the synthetic such that a guaranteed profit (even though its small) can be collected by shorting the long call and longing the synthetic?