We can synthetically create the risk profile or a short stock position by buying ATM puts and selling ATM calls.
The net result is a virtually nil cost or even net credit trade that precisely mimics the short stock or short future position.
Buy an ATM put.
Sell an ATM call with the same strike and expiration date.
Steps to Trading a Short Synthetic Future
Steps In
Try to ensure that the trend is downward and identify a clear area of resistance.
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 shorted the stock.
The difference is that with a Short 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 - Short Synthetic Future
Outlook
With Short Synthetic Futures, your outlook is bearish.
Rationale
To simulate the action of shorting a stock.
This also simulates the action of taking a short position in a future.
Net Position
This is usually a net credit 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 upside as the stock rises.
Effect of Time Decay
Time decay helps your Short 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.
What you lose from the Long Put time value, you benefit from the Short Call position.
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 shorter -term trade.
Breakeven = [Strike price + net Credit](or – Net Debit)
Exiting the Trade - Short Synthetic Future
Exiting the Position
With this strategy, you can simply unravel the spread by selling your puts and buying back the calls.
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 rise up through your predetermined stop loss.
Advantages and Disadvantages
Advantages
Create a short stock position with the ability to leg in and out of the call or put as appropriate.
Uncapped profit potential as the stock declines to zero (though this could equally be described as being capped reward after the stock has fallen to zero!).
Disadvantages
No leverage or protection created by the position.
Uncapped risk potential if the stock rises.
Bid/Ask Spread can adversely affect the quality of the trade.
