Synthetic Options vs Normal Options

[TheDawn]

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?

I think maybe volatility. And mind you, the profit on shorting the call is not guaranteed. If you get assigned, you will lose more than the premium that you have collected from shorting the call.

What strikes are you using for the call and the put? I am just curious.

 

[MrMuppet]

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?

Options are not priced on the cash market but on the forward. If you trade options with 5 days to expiry, you trade options on a forward with 5 days to expiry. Try the same position with 6month options or LEAPS and you will find that the "risk free" profit is even larger. It´s just interest rates and dividends that influence the forward thus they will influence the synthetic forward (long call/short put) as well.

By the way, you might not realize that but the trade is actually an instant loss. As already mentioned, it just yields 3,7% p.a. before fees whereas treasury yields are at 5%. So even if you traded for free and borrowed money for free your opportunity cost would still be 1,3% p.a.

 

[Robert Morse]

BINGO

By the way, you might not realize that but the trade is actually an instant loss. As already mentioned, it just yields 3,7% p.a. before fees whereas treasury yields are at 5%. So even if you traded for free and borrowed money for free your opportunity cost would still be 1,3% p.a.

 

[optionstrader2022]

By the way, you might not realize that but the trade is actually an instant loss. As already mentioned, it just yields 3,7% p.a. before fees whereas treasury yields are at 5%. So even if you traded for free and borrowed money for free your opportunity cost would still be 1,3% p.a.

100%.
I wasn't looking at the conversion to actually trade it but more so to understand what causes the difference in the price between the short call and the synthetic. SPY's forward price is greater than the current spot price while a stock like DJT's forward is less than the current spot price.

What part about having the forward price greater than the spot price makes the synthetic cheaper (relatively) to the short call? Why are traders able to long the synthetic and short the call for a (small) profit?

Is it because the person who trades the synthetic has to come up with more liquidity to enter the trade (which is connected to interest rates and dividends)?

 

[newwurldmn]

100%.
I wasn't looking at the conversion to actually trade it but more so to understand what causes the difference in the price between the short call and the synthetic. SPY's forward price is greater than the current spot price while a stock like DJT's forward is less than the current spot price.

What part about having the forward price greater than the spot price makes the synthetic cheaper (relatively) to the short call? Why are traders able to long the synthetic and short the call for a (small) profit?

Is it because the person who trades the synthetic has to come up with more liquidity to enter the trade (which is connected to interest rates and dividends)?

the forward price being greater will make the call more expensive. The synthetic (+call - put - strike) will trade at a debit.

shorting a call against the forward is just a buy write but you outlay all your carrying costs upfront.

 

[optionstrader2022]

the forward price being greater will make the call more expensive. The synthetic (+call - put - strike) will trade at a debit.

shorting a call against the forward is just a buy write but you outlay all your carrying costs upfront.

I see, thank you!

If someone wanted to buy calls on a stock, would it make more sense to buy the synthetics (because they are a relatively better deal) rather than the actual calls? Would the answer to this depend on how much cash the trader had or would it not matter because the two trades are the same either way?

I am considering just trading synthetics instead of long calls because of the slightly better pricing. If the synthetic would take up too much cash then I'll trade the calls but if the synethic wouldn't take up much cash then I don't see any reason why I shouldn't trade the synthetics instead of the long calls by themselves.

Thoughts?

 

[newwurldmn]

Economically, it depends on your cost of funding and your tax situation on dividends.

operationally it will depend on your borrowing capacity.

I think the only time a synthetic should give better pricing is there’s uncertainty in the div amount.

I see, thank you!

If someone wanted to buy calls on a stock, would it make more sense to buy the synthetics (because they are a relatively better deal) rather than the actual calls? Would the answer to this depend on how much cash the trader had or would it not matter because the two trades are the same either way?

I am considering just trading synthetics instead of long calls because of the slightly better pricing. If the synthetic would take up too much cash then I'll trade the calls but if the synethic wouldn't take up much cash then I don't see any reason why I shouldn't trade the synthetics instead of the long calls by themselves.

Thoughts?

 

[ajacobson]

You've just identified a riskless arb. Don't tell anyone.
Either that or you're getting paid extra in American spreads.

 

[poopy]

I see, thank you!

If someone wanted to buy calls on a stock, would it make more sense to buy the synthetics (because they are a relatively better deal) rather than the actual calls? Would the answer to this depend on how much cash the trader had or would it not matter because the two trades are the same either way?

I am considering just trading synthetics instead of long calls because of the slightly better pricing. If the synthetic would take up too much cash then I'll trade the calls but if the synethic wouldn't take up much cash then I don't see any reason why I shouldn't trade the synthetics instead of the long calls by themselves.

Thoughts?

No. Only as a rates arb (forward coming in) in the conversion. lol there is zero utility in buying the synthetic delta // natural. Imagine on something illiquid. You're going to look for a mkt in something with two legs / one?