What is the Significance of Synthetic Positions?

[zghorner]

I have been reading through some old journals and mega threads on this forum and from time to time synthetics get mentioned as being pretty important to understand. So after researching I have a basic understanding on the formulas and equivalent P&L charts, etc...

But what makes this concept so significant? I can see why creating synthetic long stock at a cheaper price than purchasing the underlying is beneficial but I know there is more to it than that....

I found this in Hull's "Options. Futures, and Other Derivatives":
Still I feel that I am missing some major points.

Also for anyone interested, here is a helpful video on synthetics that should be titled: "basic synthetics for dummies"

 

[traider]

you don't have to pay for theta if you adjust your portfolio delta through buying and selling of underlying

 

[BlueWaterSailor]

you don't have to pay for theta if you adjust your portfolio delta through buying and selling of underlying

Combos - i.e., stock replacement, which is the primary case described above - are essentially flat the Greeks, so none of the above is needed.

Anthony J. Saliba's excellent "Managing Expectations" has a section called "Why Synthetics Matter" which covers a variety of benefits and trade-offs. There's also a terrific set of worked examples, including calculations based on put-call parity, that show where and why it's better to trade the actual vs. the synthetic.

I'm not going to retype all of that here because the right answer is "do yourself a favor and get the book." It really is one of the best combinations of theoretical and practical advice on options trading, from a man with solid experience, that I've ever read.

(Failing that, just study the living hell out of put-call parity and all that it implies. I'm still drilling on that, on occasions when I recall it - because between that and rough, rule-of-thumb options pricing vice Pierino Ursone, that's the closest mechanical equivalent to having a "trading intuition" that I can come up with.)

S = C - P implies
P + S = C
C - S = P
-P - S = -C
-C + S = -P

Add to that the concept of 'basis':

B = Carry - Dividends
S(FV) = S + B, or
S(FV) = S + C - D

So, for an option calc at strike X, it's

C - P = S - X + B

All else - and there's a hell of a lot, and I'm still wrestling to get it all into my brain - proceeds from that.

 

[Axon]

I go for the synthetic if liquidity is better, spread is tighter, more favorable premium due to difference in IV, etc. Just compare the numbers before making your trade; it's pretty straightforward when you should and shouldn't use the synthetic version.

 

[zghorner]

Combos - i.e., stock replacement, which is the primary case described above - are essentially flat the Greeks, so none of the above is needed.

Anthony J. Saliba's excellent "Managing Expectations" has a section called "Why Synthetics Matter" which covers a variety of benefits and trade-offs. There's also a terrific set of worked examples, including calculations based on put-call parity, that show where and why it's better to trade the actual vs. the synthetic.

I'm not going to retype all of that here because the right answer is "do yourself a favor and get the book." It really is one of the best combinations of theoretical and practical advice on options trading, from a man with solid experience, that I've ever read.

(Failing that, just study the living hell out of put-call parity and all that it implies. I'm still drilling on that, on occasions when I recall it - because between that and rough, rule-of-thumb options pricing vice Pierino Ursone, that's the closest mechanical equivalent to having a "trading intuition" that I can come up with.)

S = C - P implies
P + S = C
C - S = P
-P - S = -C
-C + S = -P

Add to that the concept of 'basis':

B = Carry - Dividends
S(FV) = S + B, or
S(FV) = S + C - D

So, for an option calc at strike X, it's

C - P = S - X + B

All else - and there's a hell of a lot, and I'm still wrestling to get it all into my brain - proceeds from that.

man that book is almost nonexistent lol. A few used hardcovers on amazon for $150 and that's it...do you think it is worth that price?

 

[OptionsOptionsOptions]

• Could you give an example of a Synthetic Position?
• Most likely such a position will have a regular common name.
• But throwing in the word Synthetic adds some pizzazz to the trade - perhaps even some lipstick to a pig.

 

[JSOP]

man that book is almost nonexistent lol. A few used hardcovers on amazon for $150 and that's it...do you think it is worth that price?

No. Lots of great books out there explain derivatives really well.

 

[it365]

No. Lots of great books out there explain derivatives really well.

Can you suggest some good ones? Synthetic and overall options. In another thread you mentioned books that people usually avoid and hence don't get the true nature of options. Looking for those suggestions.

Thanks in advance.

 

[JSOP]

Can you suggest some good ones? Synthetic and overall options. In another thread you mentioned books that people usually avoid and hence don't get the true nature of options. Looking for those suggestions.

Thanks in advance.

I just read Investopedia and Wikipedia tbh and any good websites that I find via Google that are good at explaining option concepts like payoff diagrams, valuation methods, the greeks. I find them very useful and informative.

As long as you stay away from websites that advertise certain methods or strategies, you are fine.

 

[BlueWaterSailor]

man that book is almost nonexistent lol. A few used hardcovers on amazon for $150 and that's it...do you think it is worth that price?

Hard call; depends on the marginal utility of your dollars. Given the increment in understanding that I gained from it, I'd have to grit my teeth and say "yes". Although I'd probably watch the offers for a few months and see if anything new pops up.