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Synthetic Long Call

A trader is bullish in nature for short term, but also fearful about the downside risk associated with it. Here, a trader wants to hold an underlying asset either in physical form like in case of commodities or demat (electronic) form in case of stocks.

But he is always exposed to downside risk and in order to mitigate his losses, he will buy 1 ATM or OTM Put Option since ITM Put option will carry more premium than ATM & OTM Put options which are relatively cheap.

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Case 1: If the prices rise as per his calculations, he will make unlimited profits on his long position in spot/cash market.

Case 2: If the prices fall, then his loss is covered by the Put Option. The loss incurred will be the premium amount paid to buy Put option.

The net position created from Synthetic Call strategy is similar to Call Option buy strategy.

A major difference exists between buying a Call Option and Synthetic Call strategy. In a plain Vanilla Call Option you do not hold the underlying asset, whereas in Synthetic Call you will hold the underlying asset and reap the benefits of dividends, bonus issues, etc. (only in case if the underlying asset is a stock).

Break-even Point The underlier price at which break-even is achieved for the synthetic long call position can be calculated using the following formula.

Breakeven Point = Purchase Price of Underlying + Premium Paid

Risk: Limited, The formula for calculating maximum loss is given below:

Max Loss = Premium Paid + Commissions Paid

Max Loss Occurs When Price of Underlying <= Strike Price of Long Put

Reward: Unlimited Profit Potential

The formula for calculating profit is given below:

Maximum Profit = Unlimited

Profit Achieved When Price of Underlying > Purchase Price of Underlying + Premium Paid

Profit = Price of Underlying - Purchase Price of Underlying - Premium Paid

Action

Buy Shares in Cash/Future

Buy ATM Put Option

Example

RIL is trading at Rs. 2,240 levels, Mr. G is bullish in the long term, but wants to hedge himself from the fall in cash strategy goes wrong.

He will buy 1 lot (505 shares) of RIL from the future market @ Rs. 2240 and buy 1 ATM 2240 Put Option @ Rs. 80 as premium. The lot size of RIL is 505.

Reward: The gains will be unlimited since it’s a long position. His maximum loss will be Rs. 40,400 assuming he will hold his future position irrespective of the price.