SYNTHETIC LONG CALL: BUY STOCK, BUY PUT
In this strategy, we purchase a stock since we
feel bullish about it. But what if the price of the stock went down. You wish
you had some insurance against the price fall. So buy a Put on the stock. This
gives you the right to sell the stock at a certain price which is the strike
price. The strike price can be the price at which you bought the stock (ATM
strike price) or slightly below (OTM strike price).
In case the
price of the stock rises you get the full benefit of the price rise. In case
the price of the stock falls, exercise the Put Option (remember Put is a right
to sell). You have capped your loss in this manner because the Put option stops
your further losses. It is a strategy with a limited loss and (after
subtracting the Put premium) unlimited profit (from the stock price rise).
The result of this strategy looks like a Call Option Buy strategy and therefore
is called a Synthetic Call!
But the strategy is not Buy Call Option (Strategy
1). Here you have taken an exposure to an underlying stock with the aim of
holding it and reaping the benefits of price rise, dividends, bonus rights etc.
and at the same time insuring against an adverse price movement.
In simple buying of a Call Option, there is no
underlying position in the stock but is entered into only to take advantage of
price movement in the underlying stock.
When to use: When ownership is desired of stock yet investor is concerned
about near-term downside risk. The outlook is conservatively bullish.
Risk: Losses
limited to Stock price + Put Premium
– Put Strike price
Reward: Profit
potential is unlimited.
Break-even
Point: Put
Strike Price +
Put Premium
+ Stock Price
– Put Strike
Price
Example
Mr. XYZ is bullish about ABC Ltd stock. He buys
ABC Ltd. at current market price of Rs. 4000 on 4th July. To protect against fall in the price of ABC Ltd. (his risk), he
buys an ABC Ltd. Put option with a strike price Rs. 3900 (OTM) at a premium of
Rs. 143.80 expiring on 31st July.
Strategy
: Buy Stock + Buy Put Option
|
Buy Stock
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Current Market Price of
|
4000
|
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(Mr. XYZ pays)
|
ABC Ltd. (Rs.)
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|
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Strike Price (Rs.)
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3900
|
|
|
|
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Buy Put
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Premium (Rs.)
|
|
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(Mr. XYZ pays)
|
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143.80
|
|
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|
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Break Even Point (Rs.)
|
4143.80
|
|
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(Put Strike Price + Put
|
|
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Premium + Stock Price –
|
|
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Put Strike Price)*
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* Break Even is from the point of view of Mr.
XYZ. He has to recover the cost of the Put Option purchase price + the stock
price to break even.
Example
:
ABC
Ltd. is trading at Rs. 4000 on 4th July.
Buy
100 shares of the Stock at Rs. 4000
Buy 100 July Put Options with a Strike Price of
Rs. 3900 at a premium of Rs. 143.80 per put.
|
Net Debit (payout)
|
Stock Bought + Premium Paid
|
|
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Rs. 4000 + Rs. 143.80
|
|
|
Rs. 4,14,380/-
|
|
|
|
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Maximum Loss
|
Stock Price + Put Premium – Put Strike
|
|
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Rs. 4000 + Rs. 143.80 – Rs. 3900
|
|
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Rs. 24,380
|
|
|
|
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Maximum Gain
|
Unlimited (as the stock rises)
|
|
|
|
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Breakeven
|
Put Strike + Put Premium + Stock Price – Put Strike
|
|
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Rs. 3900 + Rs. 143.80 + Rs. 4000 – Rs. 3900
|
|
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= Rs. 4143.80
|
|
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The payoff schedule
|
ABC Ltd. closes at
|
Payoff from the
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Net Payoff from the
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Net Payoff
|
|
(Rs.) on expiry
|
Stock (Rs.)
|
Put Option (Rs.)
|
(Rs.)
|
|
3400.00
|
-600.00
|
356.20
|
-243.80
|
|
3600.00
|
-400.00
|
156.20
|
-243.80
|
|
3800.00
|
-200.00
|
-43.80
|
-243.80
|
|
4000.00
|
0
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-143.80
|
-143.80
|
|
4143.80
|
143.80
|
-143.80
|
0
|
|
4200.00
|
200.00
|
-143.80
|
56.20
|
|
4400.00
|
400.00
|
-143.80
|
256.20
|
|
4600.00
|
600.00
|
-143.80
|
456.20
|
|
4800.00
|
800.00
|
-143.80
|
656.20
|
The payoff
chart (Synthetic Long Call)
+ =
Buy Stock Buy Put Synthetic Long Call
ANALYSIS: This
is a low risk strategy. This is a strategy which limits the loss in case of
fall in market but the potential profit remains unlimited when the stock
price rises. A good strategy when you buy a stock for medium or long term, with
the aim of protecting any downside risk. The pay-off resembles a Call Option
buy and is therefore called as Synthetic Long Call.
