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Synthetic Short Straddle - Definition
A combination of stocks and call options which produces the same payoff characteristics as a
Short Straddle options trading strategy.
What Is Synthetic Short Straddle?
Synthetic Short Straddle transforms a basic stock position into an options trading position that profits even when the stock remains stagnant
exactly as
a short straddle options trading strategy does. This is useful when a stock position you are holding is expected to remain stagnant
and you want to profit from it. This is the kind of flexibility that
options trading grants
through the use of Synthetic Options Strategies.
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When To Use Synthetic Short Straddle?
One should use a Synthetic Short Straddle when one's existing stock holding is expected to remain stagnant
and wishes to profit from it.
How To Use Synthetic Short Straddle?
There are 2 main ways to establish a Synthetic Short Straddle. One way is by selling twice as many
At The Money (ATM) call options as you have Long stocks , known as the Short Call Synthetic Short Straddle.
The other way is by selling twice as many At The Money (ATM) put options as you have short stocks , known as the Short Put Synthetic Short Straddle.
Making Short Call Synthetic Short Straddle from Long Stock.
Example : Assuming you own 100 shares of XYZ company trading at $40 now. To transform the position into Synthetic Short Straddle, you will
Sell To Open 2 contracts (representing 200 shares) of XYZ's $40 call options.
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Making Short Put Synthetic Short Straddle from Short Stock.
Example : Assuming you are short 100 shares of XYZ company trading at $40 now. To transform the position into Synthetic Short Straddle, you will
Sell To Open 2 contracts (representing 200 shares) of XYZ's $40 put options.
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At this point, experienced options traders would notice that establishing a Synthetic Short Straddle actually creates a
Delta Neutral Position.
Making Short Call Synthetic Short Straddle from Long Stock.
Example : Assuming you own 100 shares of XYZ company trading at $40 now. To transform the position into Synthetic Short Straddle, you will
Sell To Open 2 contracts (representing 200 shares) of XYZ's $40 call options.
100 shares = 100 delta. Short 200 ATM Call Options = -100 Delta (-0.5 delta each).
Total Delta = 100 - 100 = 0
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Making Short Put Synthetic Short Straddle from Short Stock.
Example : Assuming you are short 100 shares of XYZ company trading at $40 now. To transform the position into Synthetic Short Straddle, you will
Sell To Open 2 contracts (representing 200 shares) of XYZ's $40 put options.
100 short shares = -100 delta. Short 200 ATM Put Options = 100 Delta (0.5 delta each).
Total Delta = 100 - 100 = 0
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Profit Potential Of Synthetic Short Straddle
Synthetic Short Straddle reaches maximum profitability when the underlying stock closes exactly at the
strike price of the short options.
Risk / Reward Of Synthetic Short Straddle
Maximum Profit: Limited
Maximum Loss: Unlimited
Breakeven Point Of Synthetic Short Straddle
There are 2 break even points to a Synthetic Short Straddle. One breakeven point if the underlying asset goes up (Upper Breakeven), and one breakeven point if the underlying asset goes down (Lower Breakeven). The Synthetic Short Straddle is profitable as long as it remains within the 2 breakeven points.
Upper Break Even = Option Strike Price + Extrinsic Value Of Options
Lower Break Even = Option Strike Price - Extrinsic Value Of Options
Making Short Call Synthetic Short Straddle from Long Stock.
Example : Assuming you own 100 shares of XYZ company trading at $40 now. To transform the position into Synthetic Short Straddle, you will
Sell To Open 2 contracts (representing 200 shares) of XYZ's $40 call options at $1.50.
Upper BreakEven = $40 + ($1.50 x 2) = $40 + $3 = $43
Lower BreakEven = $40 - ($1.50 x 2) = $40 - $3 = $37
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Advantage of Synthetic Short Straddle
Able to immediately transform a stock position into an options trading position which profits when the position remains stagnant.
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