Synthetic Shorts

[bwilliams5534]

Hi...thanks for taking the time to read my question.

I have recently began looking at synthetic shorts and have a few basic questions on them. (Please note: I do not want to debate the concept of a synthetic short vs, normal short or anything like that...I just want these basic questions answered if possible and you can of course throw in any other information you have. Thanks)


So,

1. Other than the larger bid and ask spread and lower volume that one will suffer from on options as opposed to the stock itself, are there any other issues that should concern me about synthetic shorting as compared to normal shorting?

2. Am I basically guaranteed that the synthetic short will work exactly as the risk profile of it is shown (same risk profile as going short) or is there instances where this profile could be thrown off and I could lose money even if I was right about the direction of the underlying or not make as much as the risk profile would led me to believe? I understand that when looking at the greeks of the trade this should be impossible, but I just want to check.

Also when dealing with further out month options:

3. When looking at different months pricing on synthetic shorts, it appears that the further out you go, the more capital you have to put up to achieve the same profit as you would in an early months...but as you go further out you also suffer from less theta and obviously have more time for your synthetic short to go your way. Other then this higher capital ratio is there any other concern I should have about going with a further out month when dealing with synthetic shorts?


Thanks.

 

[dagnyt]

Quote from bwilliams5534:


1. Other than the larger bid and ask spread and lower volume that one will suffer from on options as opposed to the stock itself, are there any other issues that should concern me about synthetic shorting as compared to normal shorting?

Synthetic pays no dividends. But that should be factored into the pric of the options.

Biggest risk: PIN risk at expiration. You will not know if you will be assigned on the calls and thus, don't know whether to exercise calls, if stock is pinned to a strike. You can roll to alleviate that problem.

2. Am I basically guaranteed that the synthetic short will work exactly as the risk profile of it is shown (same risk profile as going short) or is there instances where this profile could be thrown off and I could lose money even if I was right about the direction of the underlying or not make as much as the risk profile would led me to believe? I understand that when looking at the greeks of the trade this should be impossible, but I just want to check.

Barring a big change in interest rates which affect the shot stock rebate you don't receive, you are ok.

Also when dealing with further out month options:

3. When looking at different months pricing on synthetic shorts, it appears that the further out you go, the more capital you have to put up to achieve the same profit as you would in an early months...but as you go further out you also suffer from less theta and obviously have more time for your synthetic short to go your way. Other then this higher capital ratio is there any other concern I should have about going with a further out month when dealing with synthetic shorts?

When you buy puts and short calls (same strike/expiration) you are short stock. Look at this from the perspective of the person who takes the other side of the trade. That person is long stock. Because he/she does not have to pay interest to carry the long stock position, that trader is willing (forced) to pay more for the synthetic long stock position. Thus, you, as the seller should be collecting more, not paying more.

Margin requirements are the same, no matter what the expiration date.

Mark
http://blog.mdwoptions.com/options_for_rookies/






Thanks. [/B]

 

[MTE]

Technically it's not a synthetic stock, but a synthetic forward. In other words, the interest rate and dividends are built into the price of the synthetic.