Option Strategies Details

A trader who wants to speculate on decreasing price and increasing volatility can open a Synthetic Short. The trader may pay a small debit, receive a small credit, or open the trade for exactly $0.

Suppose stock XYZ is trading at $25.50. You forecast a decrease in price and an increase in volatility.

You open a $25 Synthetic Short at exactly $0.00, no cost, to express this view. How is this possible? The $25 Call bid price is $3.00 and the $25 Put ask price is also $3.00, so when you sell the $25 Call you receive exactly $3.00 and you use that credit to pay for the $25 Put.

The breakeven price for this trade is the exact price of the underlying when you entered since this structure behaves almost exactly like shorting 100 shares of XYZ: theta, vega, and gamma are all roughly zero and delta is roughly -100.

The max loss on this position at expiry is theoretically unlimited, since XYZ price can increase indefinitely. The max gain of a Synthetic Short is large but theoretically capped, since XYZ price can only decrease to $0. Since the loss on a Synthetic Short is theoretically unlimited, this structure carries a high "risk of ruin". The unlimited loss can be mitigated by buying a further OTM Call, which caps upside losses but makes the position more expensive to open (i.e. the debit becomes larger) and removes some of the similarities to shorting 100 shares: theta becomes negative, vega and gamma become positive, and delta drops below -100.