We can synthetically create the risk profile or a long stock by selling ATM puts and buying ATM calls.
The net result is a very inexpensive, nil cost, or even net credit trade that precisely mimics the long stock or long future position.
Sell an ATM put.
Buy an ATM callwith the same strike and expiration date.
Steps to Trading a Long Synthetic Future
Steps In
Try to ensure that the trend is upward and identify a clear area of support.
Steps Out
Manage your position according to the rules defined in your Trading Plan.
Play the strategy just as you would if you’d simply bought the stock.
The difference is that with a Long Synthetic Future, you can leg out of the trade, maximizing your trading opportunity.
Never hold the long option into the last month before expiration.
Context - Long Synthetic Future
Outlook
With Long Synthetic Futures, your outlook is bullish.
Rationale
To simulate the action of buying a stock, but to do so with a fraction of the cost.
This also simulates the action of taking a long position in a future.
Net Position
This is usually a net debit trade.
It can depend on how close the strike price is to the stock price and whether it is above or below the stock price.
Your risk on the trade itself is uncapped on the downside until the stock falls down to zero.
Effect of Time Decay
Time decay is harmful to your Long Synthetic Future trade, but with this strategy, you are hedging time decay by buying and selling near the money options, so the effect is minimal.
Appropriate Time Period to Trade
you will be using this strategy in conjunction with another trade.
It is generally more sensible to use this as a longer-term trade. Breakeven = [Strike price + net debit]
Exiting the Trade - Long Synthetic Future
Exiting the Position
With this strategy, you can simply unravel the spread by selling your calls and buying back the puts.
You can also exit just your profitable leg of the trade and hope that the stock moves to favor the unprofitable side later on.
Mitigating a Loss
Sell the position if the stock breaks down through your predetermined stop loss.
Advantages and Disadvantages
Advantages
Create a long stock position with virtually zero capital outlay.
Capped risk down to the stock falling to zero (though this could be argued the other way too; i.e., uncapped risk down to zero!).
Uncapped profit potential if the stock appreciates.
Disadvantages
No leverage or protection created by the position.
No dividend entitlement.
Bid/Ask Spread can adversely affect the quality of the trade.
