Synthetic Options
Synthetic Options
The meaning of Synthetic is Artificial. SyntheticOptions means artificial
Options. Before understanding SyntheticOptions, we should
understand that Call, Put and Futures are completely
interlinked with each other. We can mix any two products and can create third one.
For Eg. we can make SyntheticCall by joining one Future and one Put.
We can make SyntheticPut by joining one Future and one Call and
We can make SyntheticFuture by joining one
Call and one Put Options.
SyntheticOptions and Futures are
very important when we dont get liquidity in any product.
What is Synthetic Call Option
A position created by combining Future and Put Options for the purpose
of imitating the payout schedule and characteristics of a Call Options.
So when spot price falls below 5100, Mr. Y will exercise his right to sell Nifty
at 5100. So he will get benefit when market falls below 5100. So if Market falls to 4900 he will
get Rs.200 back but as he has paid Rs. 100 as premium so his net profit would be
Rs.100.
Buy Call = Buy Future + Buy Put
Mr. X has Purchased 5000 Call Option @ Rs. 100. While
Mr. Y has purchased a future at Rs. 5000 and purchase
a 5000 Put at Rs. 100.Their payoff at different
spot price is as follows.
Mr. X's Payoff
Spot Price

Payoff
Buy 5000 Call at
Rs.100

4700

100

4800

100

4900

100

5000

100

5100

0

5200

100

5300

200


Mr. Y's Payoff
Spot Price

Payoff
Buy Future at
Rs. 5000

Payoff
Buy 5000 Put at
Rs.100

Mr. Y's
Total Payoff

4700

300

200

100

4800

200

100

100

4900

100

0

100

5000

0

100

100

5100

100

100

0

5200

200

100

100

5300

300

100

200


Sell Call = Sell Future + Sell Put
Mr. A has Sold 5000 Call Option @ Rs. 100. While Mr. B has sold
a future at Rs. 5000 and sold a 5000 Put at Rs. 100. Their
payoff at different spot price is as follows.
Mr. A's Payoff
Spot Price

Payoff
Buy 5000 Call at
Rs.100

4700

100

4800

100

4900

100

5000

100

5100

0

5200

100

5300

200


Mr. B's Payoff
Spot Price

Payoff
Buy Future at
Rs. 5000

Payoff
Buy 5000 Put at
Rs.100

Mr. B's
Total Payoff

4700

300

200

100

4800

200

100

100

4900

100

0

100

5000

0

100

100

5100

100

100

0

5200

200

100

100

5300

300

100

200


Requirement of Synthetic Call
Requirement of SyntheticCall Options arises when
For Eg. Underlying Future is running at Rs.6000. Mr. X wants
to buy 5800 Call Options. Suppose, as per Black Scholes
pricing, Premium of 5800 Call should be Rs.240
and Premium of 5800 Put should be Rs.40. But due to less liquidity,
5800 Call is trading at 210 Bid and 265 offer.
So if Mr. X wants to buy 5800 Call then he has to pay Rs.265
instead of Rs.240.
So here Mr. X can buy one Future at Rs.6000 and can
buy one 5800 Put at Rs.40. The combination of both the
trade would result in Buying one 5800 Call at Rs.240.
So SyntheticCall Options can be used
as substitute of Original Options.
What is Synthetic Put Option
A position created by combining Future and Call Options for the
purpose of imitating the payout schedule and characteristics of Put Options.
Buy Put = Sell Future + Buy Call
Mr. X has Purchased 5000 Put Option @ Rs. 100. While
Mr. Y sold a future at Rs. 5000 and purchase a 5000 Call at Rs. 100.Their
payoff at different spot price is as follows.
Mr. X's Payoff
Spot Price

Payoff
Buy 5000 Call at
Rs.100

4700

200

4800

100

4900

0

5000

100

5100

100

5200

100

5300

100


Mr. Y's Payoff
Spot Price

Payoff
Buy Future at
Rs. 5000

Payoff
Buy 5000 Put at
Rs.100

Mr. Y's
Total Payoff

4700

300

100

200

4800

200

100

100

4900

100

100

0

5000

0

100

100

5100

100

0

100

5200

200

100

100

5300

300

200

100


Sell Put = Buy Future + Sell Call
Mr. A has Sold 5000 Put Option @ Rs. 100. While Mr. B has purchased
a future at Rs. 5000 and sold a 5000 Call at Rs. 100.Their
payoff at different spot price is as follows.
Mr. A's Payoff
Spot Price

Payoff
Buy 5000 Call at
Rs.100

4700

200

4800

100

4900

0

5000

100

5100

100

5200

100

5300

100


Mr. B's Payoff
Spot Price

Payoff
Buy Future at
Rs. 5000

Payoff
Buy 5000 Put at
Rs.100

Mr. B's
Total Payoff

4700

300

100

200

4800

200

100

100

4900

100

100

0

5000

0

100

100

5100

100

0

100

5200

200

100

100

5300

300

100

100


2.4.4 Requirement of Synthetic Put
Requirement of SyntheticPut Options arises when
For Eg. Underlying Future is running at Rs.6000. Mr. X wants
to buy 6200 Put Options. Suppose, as per Black Scholes
pricing, Premium of 6200 Put should be Rs.240
and Premium of 6200 Call should be Rs.40. But due to less liquidity,
6200 Put is trading at 210 Bid and 265 offer.
So if Mr. X wants to buy 6200 Put then he has to pay Rs.265
instead of Rs.240.
So here Mr. X can sell one Future at Rs.6000 and can
buy one 6200 Call at Rs.40. The combination of both the
trade would result in Buying one 6200 Put at Rs.240.
So SyntheticPut Options can be used
as substitute of Original Options.
2.4.5 What is Synthetic Future
A position created by combining Call and Put Options for the purpose
of imitating the payout schedule and characteristics of a futures contract. In simple
terms, SyntheticFuture is the position
created by combining Call and Put with same payoff.
Buy Future = Buy Call + Sell Put
Mr. X has purchased a Future at Rs. 5000. While
Mr. Y has purchased a 5000 Call at Rs. 100 and sell
a 5000 Put at Rs. 100.Their payoff at different
spot price is as follows.
Mr. X's Payoff
Spot Price

Payoff
Buy 5000 Call at
Rs.100

4700

300

4800

200

4900

100

5000

0

5100

100

5200

200

5300

300


Mr. Y's Payoff
Spot Price

Payoff
Buy Future at
Rs. 5000

Payoff
Buy 5000 Put at
Rs.100

Mr. Y's
Total Payoff

4700

100

200

300

4800

100

100

200

4900

100

0

100

5000

100

100

0

5100

0

100

100

5200

100

100

200

5300

200

100

300


Sell Future = Sell Call + Buy Put
Mr. A has sold a Future at Rs. 5000. While Mr. B has sold
a 5000 Call at Rs. 100 and purchase a 5000 Put at Rs. 100.Their
payoff at different spot price is as follows.
Mr. A's Payoff
Spot Price

Payoff
Buy 5000 Call at
Rs.100

4700

300

4800

200

4900

100

5000

0

5100

100

5200

200

5300

300


Mr. B's Payoff
Spot Price

Payoff
Buy Future at
Rs. 5000

Payoff
Buy 5000 Put at
Rs.100

Mr. B's
Total Payoff

4700

100

200

300

4800

100

100

200

4900

100

0

100

5000

100

100

0

5100

0

100

100

5200

100

100

200

5300

200

100

300


2.4.4 Requirement of Synthetic Future
Requirement of SyntheticFuture arises when
 We dont get any liquidity in Original Future
 Price of original Future is not correct
 Future does not exist. For Eg. We are getting 5 years Options in Nifty but we get
only 3 months Futures in Nifty. So by using Long term Options, we can make
SyntheticLong term Futures.
For Eg. 6000 Call is running at Rs.300 and 6000 Put is running at Rs.200.
Mr. X wants to buy Future. Now the logical price of Future in this scenario
should be Rs.6100, But suppose due to less liquidity, Future is trading at 6010
Bid and 6265 offer. So if Mr. X wants to buy Future, then he has to pay
Rs.6265 instead of Rs.6100.
For Eg. 6000 Call is running at Rs.300 and 6000 Put is running at Rs.200.
Mr. X wants to buy Future. Now the logical price of Future in this scenario
should be Rs.6100, But suppose due to less liquidity, Future is trading at 6010
Bid and 6265 offer. So if Mr. X wants to buy Future, then he has to pay
Rs.6265 instead of Rs.6100.