The synthetic short stock option strategy is created by selling at-the-money calls while also buying the same number of at-the-money puts. A type of risk reversal spread, the calls and puts have the same underlying stock and the same expiration date. The delta of the call and put should total 100% or equal to one position.
Unlimited Profit is the Good News
The good news is that synthetic short stock option strategy has unlimited profit potential. Profit is calculated by first calculating the net premium. The net premium is then added to the strike price of the long put and that is the breakeven point. When the price of the underlying stock falls below the total of the net premium and strike price, profit is generated. The actual profit will be equal to the strike price of the long put less the stock market price plus the net premium.
Unlimited Risk Exists Too
Unfortunately there is also unlimited risk associated with the synthetic short stock strategy. The unlimited loss is possible because stock prices have no upward limits. The loss is equal to the price of the stock minus the strike price of the short call minus the net premium plus the commission paid.
The synthetic short stock strategy is good to use when you don’t want to short sell stock. In addition, it’s a good strategy for use in a bear market for the underlying asset. There is also a synthetic long stock strategy which is the opposite of the synthetic short stock strategy.
Filed under General by on Apr 26th, 2011. Comment. 
Shorting stocks refers to selling stocks you don’t actually own. Naturally this can be a risky move because you might be forced to go into the market to buy stock at an undesirable price in order to complete an exercised option trade. In addition, when you short sell, the bottom line is that you are borrowing money from the broker who allows you to open a margin account with an amount that equals a percentage of the full contract amount.
Unlimited Losses
Shorting stocks has a risk of unlimited losses. When you short sell, the assumption is that the underlying asset of the option contract will go down. Since a stock price can increase in price with no limit, you are faced with unlimited losses. In effect, the market moves against your opinion that the price of the stock would fall.
Going to the Market
If you don’t own the stock underlying an option contract, you will have to buy the stock in the option market to satisfy your obligation to sell it if the option is exercised. This gives you another potential for loss when shorting stocks because you have to cover your position.
Margin Calls Can Hurt!
Shorting stocks involves margin trading. Short options trading require accounts with margin requirements. This means you open an account with a broker with an amount that equals a percentage of the margin for the futures contract. If your options trading leads to losses, the broker will issue a margin call forcing you to add cash to your account (whether you have it on hand or not!)
When you decide that shorting stocks is something you want to do, it’s important to understand the inherent risks in this strategy.
Filed under General by on Apr 19th, 2011. Comment.
A popular stock option strategy used by investors is the covered call. The covered call is one in which you would write a call option contract for a number of shares of stock you actually own. If you own the stock before writing the call option it is called an overwrite. If you buy the stock as you create the call contract, it is called a buy-write.
The stock you own is covering the call option contract which is where the name is derived from. This stock option strategy is generally used when the market is going sideways or you form an opinion that a bull market is developing.
With the covered option, the price for the underlying asset has been determined already unlike in a naked option where you don’t own the stock. When the option is uncovered, you will have to go to the market to buy the stock if and when it becomes necessary to cover the option. It is possible to cover your option at any time before the expiration date of the option contract.
The covered call stock option strategy is less risky than the uncovered option simply because you already know the price of the underlying asset. The covered call is used to generate income from the underlying asset or stock.
You get to keep the premium on the covered call and if the contract expires then you also profit from any gains in the stock value. If the option is exercised you will earn the premium in addition to the difference between the purchased stock price and the strike price. This stock option strategy can also protect you from underlying stock that that may experience a price decline.
The breakeven point for the covered call stock option strategy is equal to the stock purchase price less the premium received.
Filed under Option Trading Strategies by on Apr 12th, 2011. Comment.