The synthetic long futures (split strikes) is a less aggressive version of the synthetic long futures strategy.
The synthetic long futures (split strikes) position is created by buying slightly out-of-the-money calls and selling an equal number of slightly out-of-the-money puts of the same underlying futures and expiration month.
|Synthetic Long Futures (Split Strikes) Construction|
|Buy 1 OTM Call|
Sell 1 OTM Put
The split strike version of the synthetic long futures strategy offers some downside protection. If the trader's outlook is wrong and the underlying futures price falls slightly, he will not suffer any loss. On the flip side, a stronger upside move is needed to produce a profit.
Profits and losses with a split strike strategy are also not as heavy as a corresponding long futures position as the strategist has traded some potential profits for downside protection.
Similar to a long futures position, there is no maximum profit for the synthetic long futures (split strikes) strategy. The options trader stands to profit as long as the underlying futures price goes up.
The formula for calculating profit is given below:
Like the long futures position, heavy losses can occur for the synthetic long futures (split strikes) if the underlying futures price falls sharply.
Often, a credit is received when establishing this position. Hence, even if the underlying futures price remains unchanged on expiration date, there will still be a profit equal to the initial credit received.
The formula for calculating loss is given below:
The underlier price at which break-even is achieved for the synthetic long futures (split strikes) position can be calculated using the following formula.
Suppose June Crude Oil futures is trading at $40 and each contract covers 1000 barrels. A trader creates a split-strikes synthetic long futures position by selling a JUN 35 put for $2200 and buying a JUN 45 call for $2000. The net credit taken to enter the trade is $200.
If June Crude Oil futures rallies to $45 on option expiration date, both the short JUN 35 put and the long JUN 45 call will expire worthless and the trader gets to keep the initial credit of $200 as profit.
If June Crude Oil futures skyrockets to $60 on option expiration date, the short JUN 35 put will expire worthless but the long JUN 45 call will expire in the money and has an intrinsic value of $15000. Including the initial credit of $200, the options trader's profit comes to $15200. Comparatively, a corresponding long futures position would have achieved a higher profit of $20000.
If the price of June Crude Oil futures has instead nosedived to $20, the long JUN 45 call will expire worthless while the short JUN 35 put will expire in the money and be worth $15000. Buying back this short put will require $15000 and subtracting the initial $200 credit received when entering the trade, the trader's loss comes to $14800. A heavier loss of $20000 loss would have been suffered by a corresponding long futures position.
There is a more aggressive version of this strategy where both the call and put options involved are at-the-money. While a smaller upside movement of the underlying futures price is required to accrue large profits, this alternative strategy provides less margin for error.
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