Fundamentals

Synthetic Short

A synthetic short involves selling a call option and buying a put option with the same strike price and expiration date. Investors may use a synthetic short when seeking exposure similar to short selling the underlying stock without borrowing shares directly. Synthetic shorts allow investors to potentially benefit from downward price movement using options contracts.

Outlook: Bearish
Use: Primarily used when expecting the stock price to fall and seeking short stock-like exposure through options
Profit: You may profit if the stock price falls below the strike price, similar to being short shares outright
Loss: You may incur losses if the stock price rises significantly above the strike price, which can be substantial

Risks

Synthetic shorts can provide short stock-like exposure using options, but the strategy carries substantial upside risk because of the short call position. If the stock price rises sharply, losses may resemble those of a traditional short stock position. Investors should also consider assignment risk, margin requirements, and implied volatility.

Basic example

Let’s say FlyFit is trading at $100 and you expect the stock price to fall. You establish a synthetic short by selling one $100 call for $6 and buying one $100 put for $4.

Strike price: $100
Both contracts use the same strike price and expiration date.
Contract prices: $6 Short Call, $4 Long Put
Per-share premium for each option leg
Total credit: ($6 - $4) x 100 = $200
The total credit received is equal to the premium received for the call option less the premium paid for the put option.

Maximum profit and loss

The P/L calculations take into consideration both the short call and long put positions.

Max loss: Unlimited
Losses can continue increasing as the stock price rises.
Breakeven: $98
Strike price - net premium received
Max profit: Substantial
The maximum profit is limited to the stock price falling to $0.

Profit if...

FlyFit’s stock price falls below the breakeven.

Total profit: ($100 - $90 + $2) x 100 = $1,200
Difference between the strike price and the current stock price, plus the net premium received

If FlyFit falls to $90 at expiration, the put option gains intrinsic value while the call expires worthless.

Loss if...

FlyFit’s stock price rises significantly above the strike price.

Total loss: ($110 - $100 - $2) x 100 = $800
Difference between the current stock price and the strike price, less the net premium received

If FlyFit rises to $110 at expiration, the short call gains intrinsic value against you while the put expires worthless. The premium received helps offset a portion of the loss, but upside exposure remains substantial.

Brokerage services for US-listed securities and options offered through Public Investing, member FINRA & SIPC. Supporting documentation upon request.

The examples used above are fictional, and do not constitute a recommendation or endorsement of any investment.

Options are not suitable for all investors and carry significant risk. Certain complex options strategies carry additional risk. There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, among others, as compared with a single option trade.

Prior to buying or selling an option, investors must read the Characteristics and Risks of Standardized Options, also known as the options disclosure document (ODD).

Option strategies that call for multiple purchases and/or sales of options contracts, such as spreads, collars, and straddles, may incur significant transaction costs.