synthetic long option question

[joesxm3]

I was watching a video where a guy said that when he does a synthetic long, the selling of the put "protects" the call.

The definition of synthetic long in this case seems to be 1) buying a LEAP call at an in the money strike price. 2) selling a put with the same strike and duration.

I asked on a different forum and was told that selling the put at the same strike price as buying the call:

1) caused the delta to be 100%
2) cancels out the theta since the decreasing theta of the call is cancelled by the increasing theta of selling the put
3) the credit from selling the put reduces the debit from buying the call.

I am trying to process this. The other forum did not have threads and was the type where you sit and chat, so I figured it easier to ask here.

I am trying to understand the difference between just buying the stock compared to buying the call. I can see that both would increase intrinsic value if the price goes up, but I guess that the option has to take into account time decay (theta).

So, if the price goes up, the value of the call option will go up based on the intrinsic value (difference from strike to current price) adjusted for the delta (sensitivity of option price to movement in stock price) but the option price will also add in a time value premium (theta) that will reduce as it gets closer to expiration. Do I have this right?

The strategy that the guy in the video seems to use is to buy long duration so he has time to play with things and is not subject to short term swings.

I think that if the price of the underlying stock goes up a lot, the price to "buy to close" on the put will go down and he would close it when he thinks that the price of the underlying is near a top.

If I thought the price of the underlying was at a top, would I want to "sell to close" on the call option to lock in the profit?

If the price of the underlying went flat once at the top, if I held the option more towards expiration, would the amount I could get from "sell to close" go down due to the time value dropping?

Thanks in advance for any explanations. I apologize for being such a newbie at this. I read the "options for beginners" book that was recommended a while ago and am little by little trying to understand things.

 

[NW-Bound]

A synthetic long option play gives you the same gain and loss as if you buy the stock.

The difference with buying the stock is that with the synthetic long you only need to have enough to meet the 50% margin requirement to guarantee the put. This means that you can get the gain and loss as if you buy a stock worth 2x the amount that you commit to the trade.

In other words, this is a 2x leverage play. If the stock advances 50%, you double the money that you use to guarantee the put. If the stock declines 50%, you lose all your money.

Needless to say, I never do this. My stock AA is never 100%, let alone 200%.

I guess this move can come in handy in special situations. For example, let's say you have $100K of cash coming from selling a property and you are going to use the proceed to buy stock. The market drops and you want to buy now so as not to miss out the opportunity, but the cash is not yet in hand. You have only $50K now and use a synthetic long to buy $100K worth of stock before the cash arrives.


PS. The next question to ask is, what the difference between this and buying stock on margin. I don't know the answer.

 

[Montecfo]

Both options at same duration and price makes no sense to me. The put would need to be at a higher price to create margin and reduce cost.

 

[joesxm3]

I tried to make a real-world example this morning.

SQ was trading at $162.96

Jan 20 2023 duration contracts

$160 strike, last $29.20 for call (delta = .6185), $25.85 for put (delta = -.3885).

So, you buy the call contract for $2920 and sell the put for $2585, so the net cost of the call is $335.

I got the impression that the put had to be backed 100% or $16,000 cash or equities.

So, if SQ goes from $160 to $200, the 100 shares in the contract go up by $4000.

The claim is that the $4000 gain with only $335 out of pocket is a huge percentage, but I think it ignores the cost of tying up the $16,000 and the large risk of not picking the bottom correctly.

NW-Bound, the choice of the 1 year or longer duration is said to allow time for his thesis on the stock to develop. He says that he is confident on his thesis, but not confident that he can predict it to occur in a short time frame. It struck me that this is different from your strategy of keeping the time frame short, but then I started to think that these are two different option plays so it is comparing apples and oranges.

All being said, I am too inexperienced to risk this other than on a paper trade, and the stock price is too large for me to bite into a 100 share contract. So I ended up buying a few more shares of SQ today rather than doing any options.

Thanks for the help. I appreciate you putting up with me. I am sure some of my questions are sort of stupid or misguided since I am still trying to wrap my head arount this stuff.

 

[joesxm3]

I have a question about intrinsic value and delta.

Same SQ option January 20, 2023. SQ at $162.96

strike $160 call $29.20, delta .6185

strike $155 call $33.35, delta .6449

It would seem that the two strikes should have the same time value since they expire on the same day? Is that true? Is the time value a dollar amount or a percentage of the price? That is, would the dollar amount of the time value on each be different, but the same percentage of something?

It would seem that the intrinsic value between the two should be $5, but maybe adjusted by the delta, which is less than 1.00, so as I understand it, the price difference between the two strikes should be less than $5. However, simply multiplying by the delta values I listed is close, but not an exact match.

Am I understanding it correctly that for two strikes of the same duration, the time value should be the same or at least similar?

Am I understanding it correctly that the price difference between the two strikes should be $5 times the delta value? Is the apparent deviation just a reflection of the inefficiency of the market based on the bid and ask prices? I guess it may also be due to me taking the "last" price, which may not match the current stock price that I listed.\

Thanks.

 

[Retireby45ish]

Options are complex. I’m a professional (15 years trading them for companies) and I can tell you that this person is doing nothing more than leveraging his bets as NW-Bound pointed out. Your example is similar…same exposure to the underlying with some major leverage.

The trick with options is understanding that there is no free money or strategy that makes extra money. Anyone who claims they have edge or a strategy is wrong. They can be used to add or subtract volatility from the portfolio…or to place speculative bets. But there is no added value to trading them.

This persons thesis is a pipe dream. There are thousands of professionals around the world spending tens of millions testing complex strategies using rigorous data analysis. And even those thesis/strategies only work until
they don’t. Is this person trying to sell something? Would love to see the link to his page to assess his strategy.

selling covered calls or cash secured puts are the only useful strategies that I would advise anyone use if they fit your strategy or needs. But Again no extra $$ anywhere

No such thing as a dumb question. Especially with options. Good luck! Hope this helps you.

 

[Retireby45ish]

I have a question about intrinsic value and delta.

Same SQ option January 20, 2023. SQ at $162.96

strike $160 call $29.20, delta .6185

strike $155 call $33.35, delta .6449

It would seem that the two strikes should have the same time value since they expire on the same day? Is that true? Is the time value a dollar amount or a percentage of the price? That is, would the dollar amount of the time value on each be different, but the same percentage of something?

It would seem that the intrinsic value between the two should be $5, but maybe adjusted by the delta, which is less than 1.00, so as I understand it, the price difference between the two strikes should be less than $5. However, simply multiplying by the delta values I listed is close, but not an exact match.

Am I understanding it correctly that for two strikes of the same duration, the time value should be the same or at least similar?

Am I understanding it correctly that the price difference between the two strikes should be $5 times the delta value? Is the apparent deviation just a reflection of the inefficiency of the market based on the bid and ask prices? I guess it may also be due to me taking the "last" price, which may not match the current stock price that I listed.\

Thanks.

The time value is different on each strike because they are distinct options. It’s a dollar amount.

Delta isn’t directly related to a time value. Linked, but no simple math relationship.

The time value would be. (Assuming no dividends or interest rates).

160 strike. 29.20-2.96 = 26.24
155 strike. 33.35 - 7.96 = 25.39.

2.96 is from 162.96-160. That is the intrinsic value.

This means at expiration if the stock is in the same place of 162.96 then you would have lost $26.24 from buying the 160 call.

At expiration if both strikes are under the price of the stock then the difference between them would be $5. That’s the most the difference can ever be. now it’s $4.15

 

[joesxm3]

selling covered calls or cash secured puts are the only useful strategies that I would advise anyone use if they fit your strategy or needs. But Again no extra $$ anywhere

Thanks.

The synthetic long was not recommended for us normal people. In fact it was warned against.

The one option tactic that he uses that seems to be useful to me eventually is to sell covered calls at an apparent local price top as a way to hedge the equity position if you want to continue to own the underlying through the downswing, perhaps to avoid triggering a taxable event. This would be part of a swing trading strategy on a stock you have strong conviction for in the long term.

The focus is on high-growth stocks, so it was said that the strategy of trying to buy these type of stocks by selling puts in an up trending market does not work too well because you never get assigned.

In my case, I currently have most of my stocks in an IRA, so I can swing trade without worrying about taxes. I am tossed between just selling them at tops or selling covered calls. I probably will end up holding a core position and just selling 30% into swings. Being new, many of these stocks are too high priced for me to handle even a single contract without feeling overextended.

I am definitely following the advice from here and from the you tube guy to not do options until you fully understand them and have practiced with paper trading for a while and been successful.

 

[OverThinkMuch]

Options are complex. I’m a professional (15 years trading them for companies) and I can tell you that this person is doing nothing more than leveraging his bets as NW-Bound pointed out. Your example is similar…same exposure to the underlying with some major leverage.

You should open a Q&A thread! But in case you don't, I read about using a box spread as a cheaper margin loan. Essentially it automatically loses money at some future point, but you get money up front - the difference acting like a loan's interest rate. Here's the risks I understand:

(1) Only use index options (European style). One Robinhood investor got assigned, watched Robinhood screw it up, and lost 2000%.
(2) Only use a margin account. I tried opening a put spread in my Vanguard IRA, and Vanguard locked up the full amount of the put I sold - ignoring the protective put I bought.

Given that list of risks, and the benefit of cheap loan interest, am I missing anything?

 

[OverThinkMuch]

In other words, this is a 2x leverage play. If the stock advances 50%, you double the money that you use to guarantee the put. If the stock declines 50%, you lose all your money.

Why did you say it's 2x leverage?

I think it's much higher leverage than that. I'll use SPY (at $475/sh now) options expiring Dec 2023 for an example:

2023 Dec call $475 strike last trade $54.80/sh
2023 Dec put $475 strike last trade $53.14/sh
These (and almost all) contracts are for 100 shares. One apology: the last trades were on different days, so they should not be compared like I'm doing.

So you buy a call for $5480, and sell a put for $5314. For a net investment of $166, you get the gains and losses of $47,500 worth of stock. So this is why I disagree with the earlier poster: I'm seeing 295x leverage.

Let's say SPY drops 1% with nearly 300x leverage, and the call drops by $4/sh and put goes up by $4/sh. This 1% drop scenario gives a 400% loss ($800) on the $161 invested.

This synthetic long is a cheap way to get exposure to a stock or index, but you need to have sufficient cash reserves when it goes badly. Someone using 300x leverage will eventually see things go badly.

 

[NW-Bound]

Why did you say it's 2x leverage?

I think it's much higher leverage than that. I'll use SPY (at $475/sh now) options expiring Dec 2023 for an example:

2023 Dec call $475 strike last trade $54.80/sh
2023 Dec put $475 strike last trade $53.14/sh
These (and almost all) contracts are for 100 shares. One apology: the last trades were on different days, so they should not be compared like I'm doing.

So you buy a call for $5480, and sell a put for $5314. For a net investment of $166, you get the gains and losses of $47,500 worth of stock. So this is why I disagree with the earlier poster: I'm seeing 295x leverage.

Let's say SPY drops 1% with nearly 300x leverage, and the call drops by $4/sh and put goes up by $4/sh. This 1% drop scenario gives a 400% loss ($800) on the $161 invested.

This synthetic long is a cheap way to get exposure to a stock or index, but you need to have sufficient cash reserves when it goes badly. Someone using 300x leverage will eventually see things go badly.

As I wrote earlier, in order for your broker to allow you to sell a put on $47500 worth of stock, you must have 1/2 of that much in cash or another stock as collateral. In order to be allowed this play, you need a capital of $23750 for collateral. That's why it is a 2x leverage.

If the stock drops 50%, that collateral for the put is toast.

If you write puts in an IRA like I do for no tax complication, because an IRA account cannot be a margin account, you need to have 100% of the put collateral in cash. You might as well buy the stock instead of this play because you cannot get leveraged.

In an after-tax margin account, the collateral for the put does not have to be in cash and can be other long positions. If the synthetic long moves against you, your broker will liquidate your other stocks. He is not going to let you play the roulette without having something to cover your bets.

PS. My brokerage offers several cash-like money market funds as a sweep fund. Only some can be used to hold collateral for the puts. I guess even some of these money markets have the risk of losing money in a market crash, hence are considered too unsafe by the SEC to guarantee the puts. The requirement is that strict for a cash-covered put in an IRA.

 

[bada bing]

Portfolio margin (only available to taxable brokerage accounts with a minimum balance requirement) is what makes plays like synthetic longs really work. Portfolio margin collateral requirements are significantly less than regular margin.

If you have portfolio margin, it is possible to lever up well past 2x although no where near 300X. Depending on the collateral held, maybe 5x maximum. The real utility of a synthetic long is the leverage, if leverage is something you want. Open option positions covered by margin don't get charged margin interest, although available margin is used to calculate the available "buying power". Synthetic longs are cheap leverage because the only out-of-pocket cost is the difference in the premiums for the short put and long call.

All academic to me though. I have portfolio margin enabled on my taxable brokerage account, but would never use it for something like a leveraged bet on a stock.

 

[joesxm3]

Why did you say it's 2x leverage?

I think it's much higher leverage than that. I'll use SPY (at $475/sh now) options expiring Dec 2023 for an example:

2023 Dec call $475 strike last trade $54.80/sh
2023 Dec put $475 strike last trade $53.14/sh
These (and almost all) contracts are for 100 shares. One apology: the last trades were on different days, so they should not be compared like I'm doing.

So you buy a call for $5480, and sell a put for $5314. For a net investment of $166, you get the gains and losses of $47,500 worth of stock. So this is why I disagree with the earlier poster: I'm seeing 295x leverage.

Let's say SPY drops 1% with nearly 300x leverage, and the call drops by $4/sh and put goes up by $4/sh. This 1% drop scenario gives a 400% loss ($800) on the $161 invested.

This synthetic long is a cheap way to get exposure to a stock or index, but you need to have sufficient cash reserves when it goes badly. Someone using 300x leverage will eventually see things go badly.

Seeing this prompts a question.

If the synthetic long has a delta of 1.00, is the change to the option premium based on dollars or on percentage?

That is, if the underlying drops by 1% does the option change by 1% of the option price, or by the dollar amount that is 1% of the underlying?

 

[joesxm3]

Why did you say it's 2x leverage?

I think it's much higher leverage than that. I'll use SPY (at $475/sh now) options expiring Dec 2023 for an example:

2023 Dec call $475 strike last trade $54.80/sh
2023 Dec put $475 strike last trade $53.14/sh
These (and almost all) contracts are for 100 shares. One apology: the last trades were on different days, so they should not be compared like I'm doing.

So you buy a call for $5480, and sell a put for $5314. For a net investment of $166, you get the gains and losses of $47,500 worth of stock. So this is why I disagree with the earlier poster: I'm seeing 295x leverage.

Let's say SPY drops 1% with nearly 300x leverage, and the call drops by $4/sh and put goes up by $4/sh. This 1% drop scenario gives a 400% loss ($800) on the $161 invested.

This synthetic long is a cheap way to get exposure to a stock or index, but you need to have sufficient cash reserves when it goes badly. Someone using 300x leverage will eventually see things go badly.

My other question is that in this example you seem to assume that the call and the put will both change in value based on the change in the underlying. I can see that. But if you were to want to close the trade to cut losses, would you not just buy back the put and leave the call go on to expire worthless?

So, instead of $400 lost on the call, would in not just be $161 lost?

In the examples that the you tube guy gave of his live trades, it seemed that he would wait until the cost of buying back the put got low enough, then he would buy back the put. I think this would eliminate the majority of the risk associated with the trade.

That being said, I now have a much better understanding of why the synthetic long is very risky. If the trade goes against you, you can get skinned really bad.

 

[joesxm3]

Seeing this prompts a question.

If the synthetic long has a delta of 1.00, is the change to the option premium based on dollars or on percentage?

That is, if the underlying drops by 1% does the option change by 1% of the option price, or by the dollar amount that is 1% of the underlying?

I may have cleared this up a bit with some Google searching.

I think the root of my confusion was that I thought that the delta was related to the volatility of the underlying stock. For example, some tech stock would have a higher delta than some dividend stock.

I see now that the delta exists on a curve and the farther you get from the current price = strike price the delta increases until it gets close to 1.00 when it is far from the strike price.

It seems to me that the change is expressed in dollar terms, so with a delta of 0.75, a one dollar increase in the price of the underlying would cause the price of that particular contract to go up by about $0.75.

Is it true that once the underlying has gone up one dollar and the price of the option contract changed, that the delta will have also changed slightly, so the next dollar increase in the underlying would not have the exact same effect on the price?

 

[OverThinkMuch]

My other question is that in this example you seem to assume that the call and the put will both change in value based on the change in the underlying. I can see that. But if you were to want to close the trade to cut losses, would you not just buy back the put and leave the call go on to expire worthless?

So, instead of $400 lost on the call, would in not just be $161 lost?

The put isn't free. You sold the put for $5314 originally, and the price got $400 worse. In reality, you don't buy/sell at the midpoint, so there will be some added costs. But call it $5714 ... you have to pay $5714 to buy the put back. If you do that, you lost -3450% of your original investment.

This synthetic position does not work when you split it up - you have to close both, or keep both. So instead of closing the put for a big loss, you should close the put then close the call (by selling it).

When a stock gets more volatile, the option prices go up. That reflects increased time value, and the increased chance the stock moves into the money. I don't look at delta much so I've forgotten exactly what factors go into it. When I was more interested in options, I bought "Understanding Options" 2nd edition which is $12 for paperback or kindle edition.
https://www.amazon.com/dp/B00GWSXX8U/

You can also browse online if you prefer that approach.

 

[joesxm3]

I bought the understanding options book when you originally recommended it. It helped quite a bit to get me started understanding what is going on, but I still have a long way to go.

Maybe closing both parts makes sense if the trade has gone against you. However, in the examples the guy on you tube has shown from his real life trades, if the price of the underlying goes up as planned, he buys back the put when the price is near the top and then sells a covered call, while continuing to hold the call he originally bought. I think this may be for stocks that he has a high conviction in and plans to exercise the call at expiration.

In any case, you guys have shown me that this is highly leveraged and definitely risky.

I will have to give some further thought to comparing having bought the actual stock versus selling the put as the price drops.

 

[OverThinkMuch]

I bought the understanding options book when you originally recommended it. It helped quite a bit to get me started understanding what is going on, but I still have a long way to go.

That's good. That book will explain delta better than I could.

Maybe closing both parts makes sense if the trade has gone against you. However, in the examples the guy on you tube has shown from his real life trades, if the price of the underlying goes up as planned, he buys back the put when the price is near the top and then sells a covered call, while continuing to hold the call he originally bought. I think this may be for stocks that he has a high conviction in and plans to exercise the call at expiration.

If this person thinks the stock won't go higher, why not sell the call they're holding, instead? If the stock drops, selling earlier was better. If the stock goes up, holding both long & short calls means there's no gains - the two calls cancel each other out.

It's also a little confusing that they wanted a synthetic long position established with a put and call option... and now they're talking about a covered call, which can only be sold if they already own the underlying assets. If they own the assets, why have the synthetic long?

 

[joesxm3]

I am probably out on a limb trying to explain something I am trying to understand, but . .

He describes the buying of the call and selling of the put as a way of controlling a lot of stock without putting out a lot of cash. He says he has huge positions of stuff like TSLA that would trigger very large capital gains tax if he were to sell. He feels that TSLA is a very good long term hold so he uses that to back stop the selling of puts.

He sells the covered calls when the equity is over bought as a way of going short. He does not want to close his LEAP because he feels this is only a local top and the underlying will go higher in the long run, which is why he buys contracts with very long duration.

I think he buys back the puts when the stock has gone up near the top because the cost of doing that is only like 10% of what he sold them for and it would free up the capital that is backing the puts.

For some like TSLA he holds equity and LEAP options. So, when he sells the calls, he may be doing that against his equity holding or, since he has very high options authority , he may be selling naked calls.

He says that he can take very large risks on the options because options and crypto are only 1/3 of his portfolio. He said that he started out by selling covered calls like you guys do back in the 1980's and every time he made a couple hundred thousand, he bought a rental property in CA (before the bubble), so his rental properties are more than enough to support him if he goes to zero on options and crypto.

He warns people not to do this stuff themselves. He actually got worried that people were copying his trades without understanding, so he stopped giving the exact details of his trades in real time and only now talks in generalities.

For people like me, he suggests selling covered calls and later possibly using some options to hedge our other positions.

Then again, he may be a cat . . .

 

[NW-Bound]

Selling covered calls when I think a stock I hold is near a local maximum and cash-covered puts when a stock is near a local minimum is my way of doing swing trading. The reward is less than true swing trading, but so is the risk.

I don't know what the above has to do with synthetic long.

 

[OverThinkMuch]

He describes the buying of the call and selling of the put as a way of controlling a lot of stock without putting out a lot of cash. He says he has huge positions of stuff like TSLA that would trigger very large capital gains tax if he were to sell. He feels that TSLA is a very good long term hold so he uses that to back stop the selling of puts.

He sells the covered calls when the equity is over bought as a way of going short. He does not want to close his LEAP because he feels this is only a local top and the underlying will go higher in the long run, which is why he buys contracts with very long duration.

I think he buys back the puts when the stock has gone up near the top because the cost of doing that is only like 10% of what he sold them for and it would free up the capital that is backing the puts.

For some like TSLA he holds equity and LEAP options. So, when he sells the calls, he may be doing that against his equity holding or, since he has very high options authority , he may be selling naked calls.

Yeah, I understand you're understanding something new and describing it - I appreciate you trying to explain further. And I know it's tricky!

But I see now that he means keep a long duration call (a LEAP lasts 2-3 years), and sell a shorter duration call (maybe months). It's trying to profit off a short term drop, while keeping the calls long term.

But even with LEAPS, the options eventually come due. The profits will have to be realized sometime up to and including the expiration date.

 

[joesxm3]

I am not sure, but I think he sells the calls at the same duration as the leap in order and to use the leap to cover the call and get a larger premium, but he then buys the calls back early. He recently sold TSLA calls with strike of $1200 when TSLA was $998 going up and bought them back under $900. However, he does also hold TSLA equity so he may have used that.

 

[OverThinkMuch]

I am not sure, but I think he sells the calls at the same duration as the leap in order and to use the leap to cover the call and get a larger premium, but he then buys the calls back early. He recently sold TSLA calls with strike of $1200 when TSLA was $998 going up and bought them back under $900. However, he does also hold TSLA equity so he may have used that.

That's not a covered call. Like at Vanguard, they will not allow selling of naked calls. Either you have 100 shares of stock per contract, or you can't sell a call option. A covered call always requires 100 shares.

When you both buy and sell a call with the same duration, you're creating a "spread". Between the two calls, you can gain or lose money. Outside the spread, there's no change. Maybe an example will help.

You think SPY will drop near $300. So you buy a SPY $200 call, and sell an SPY $300 call. If SPY stays over $300, you have $100/sh profit. It doesn't matter if SPY is $500 or $800, because what you owe is offset by what you have. If SPY drops all the way to $100 at expiration, both calls are worthless. Doesn't matter if SPY is $180 or $140, because there's no intrinsic value left (there is "time value" until expiration).

So they are creating a "bull spread", where they expect the stock to stay above a high point of the two prices. Hope that's educational - I didn't learn about spreads until well after learning about calls and puts.