Explained: What is Option Synthetics?

Some may say that synthetics are formed by using calls/puts/futures in a combination. However, honestly, you can design any kind of payoff chart by using options only.

In India, more than 90 per cent of the trading is done in the derivatives segment. However, the fun fact is that most of the traders lack knowledge about it.  

So, let’s know what Option Synthetics is. In simple words, it is a method to recreate the payoff and risk of a particular instrument using combinations of different options. The main motive behind all this is to cut down the costs and increase your profits.  

Some may say that synthetics are formed by using calls/puts/futures in a combination. However, honestly, you can design any kind of payoff chart by using options only. You just have to remember some golden rules such as: 

 Future buy+ Put buy= Synthetic Long Call 

(Holding underlying stock and entering a long position on put option)  

Future buy+ Call sell= Synthetic Short Put 

(Holding underlying stock and entering a short position on call option)  

Future sell+ Call buy= Synthetic Long Put 

(Short selling stock and entering a long position on call option)  

Future sell+ Put sell= Synthetic Short Call 

(Short selling stock and entering a short position on put option)  

There are many advantages of option synthetics that traders must be aware of. Firstly, it allows risk hedging. With the help of it, you can restrict your losses even if the price of an underlying asset goes in an adverse direction. Also, an investor can modify his existing position without closing the same. As a result of this advantage, your transactions might get reduced but then, you will save the transaction costs.  

There are multiple charges in the case of futures that a trader may need to pay. Huge security transaction tax (STT) charges and high brokerages reduce the total amount of profit. On the other hand, option synthetics charge less and assist investors in order to gain more. It not only helps in increasing your profits but also, requires fewer margins as you don’t need them to buy a stock. Mark to market loss is not settled on a daily basis and can be adjusted against the collateral till you actually book the loss.  

The only major problem in the case of options is the liquidity issue. Indian markets have low liquidity in some contracts that are beyond the current month.  

There are always some myths about option trading strategies such as, ‘triple straddle has a huge advantage’ or ‘inverted strangle has an advantage over strangles’, etc. Sometimes, traders avoid options because of the low probability of getting success or other factors like constant time (theta) decay. And, on the other hand, they buy puts ‘to hedge’ while trading futures. There are misconceptions, which can be cleared by spreading awareness about the topic.   

In a nutshell, it’s always a better option to understand and use option synthetics rather than gathering too much information and doing multiple trades to arrive at a good profit!