TOOLS OF THE TRADE

THE SYNTHETIC LONG PUT

The inverse of the married put, which was covered last week, is the synthetic long put.  The position comprises two trading instruments, 1) short stock and 2) a long call.  As you may recall from our discussion of short stock, the trader borrows stock from his/her broker and sells those shares into the market hoping that the share value will decrease.  When and if that happens, the trader will buy back (cover) the shares and return them to the broker and in the process will register a profitable trade.  As we know from our prior understanding of the short stock position, it is accompanied by substantial risk in that the stock has unlimited upside potential which represents the risk in the position.  In order to mitigate that risk, the trader can merely add a long call ‘at the money’ and hedge the upside risk.  The resulting position is the synthetic equivalent to that of the long put. 

Review the risk graph and you will gain an understanding of the risk and reward of the position.  Best, Robin

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