Options Trading Made Easy: Synthetic Long Put Straddle

Options Options Trading
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There’s more than one way to create a “synthetic long straddle.” Two, in fact: One by using calls and the other by using puts.
In this article we’re going to focus on the put-based strategy, even though both mimic precisely the profit/loss profile of a regular long straddle. We separate the two simply because there are separate circumstances and reasons a trader might decide to employ one over the other.synthetic-long-put-straddle

The Synthetic Long Put Straddle

Let’s first recall that a long straddle is a strategy that possesses limited risk and unlimited reward, and is geared toward an underlying security that one expects to make a big move prior to options expiration.
A long straddle is composed of the purchase of:

  1. An at-the-money call option; and
  2. An at-the-money put.

The synthetic version, however, (using puts) has three components:

  • 100 shares of the underlying security; and
  • Two long at-the-money puts.

But why not use a regular straddle? What’s the difference?
There are a few reasons you might opt for the synthetic version over the traditional, including:

  1. You already own the shares and an earnings announcement is coming that you believe might engender a big move – you’re just not sure which way. By purchasing two at-the-money puts against your shares, you neutralize the risk of a big loss should the shares plummet, yet still hold on to the possibility of a handsome gain if the stock rises.
  1. Closing out your long stock position and opening a long straddle might entail substantial commission costs – particularly if you were interested in holding the stock for the long term and had to reopen your long stock position after the options expired. The synthetic route helps you avoid the commissions headache altogether.
  1. Finally, you may be interested in the benefits of stock ownership: dividends, voting rights, etc. By holding the shares and selling puts against them, you maintain those rights.

To sum, the synthetic route offers you an opportunity to hold on to a longer-term position while weathering a potential near-term storm.

The Way It Works

Let’s have a look at a real-life example to get a better handle on the nuts and bolts of the thing.
Here’s a six-month chart of Kimberly-Clark (NYSE: KMB):
kmb synthethic long put straddle
At the end of July your research tells you that a long position in Kimberly-Clark will pay off nicely – and a better than 3% dividend yield never hurt, either.
You buy 100 shares at exactly $114 (red circle) and watch the stock rise through the beginning of August.
But then the news starts to sour, and you wonder if you should bail out. The stock drifts sideways and rumors abound regarding product safety litigation and weak forward earnings estimates. By the middle of August the stock has again retraced to $114 and you can’t bear the anxiety. You immediately buy two at-the-money November puts for $2.50 each, creating a synthetic straddle, and breathe a long sigh of relief (blue circle).

The Breakdown

Should the stock rise to $119 by the third week in November, the puts will expire worthless, but you’ll break even ([$114 + $2.50 + $2.50] x 100). Anywhere above that level and you’ll have a profit.
Should the stock remain at $114 or drop, the maximum loss you’ll sustain is $500 – the initial cost of the two long puts ($2.50 x 2 x 100).
To wit: At the $114 mark, the puts expire worthless, the stock is worth the same, and you’re out your initial premium of $500. Below that – at, say, $104 – the stock is down $1,000, the puts are in the money $10 each (for a gain of $2,000) and the initial cost of the puts is $500.
Final tally: $2,000 – $1,000 – $500 = $500 profit.
In the Kimberly-Clark example above, the stock closes just a trace above $119 (black circle), putting you in a marginally profitable position, having weathered the storm safely and ready to move forward with confidence.

You won’t find this anywhere else

You’ll never read about this powerful trading strategy in the Wall Street Journal. Or see it discussed on CNBC. 99 out of 100 brokers know nothing about it. Yet this nearly risk-free trading system has been able to turn $330 into $3,300. And it’s been put together by one man who wants to share its secrets with you. Discover them right here.

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