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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 pay-off 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 pay-off 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 pay-off 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 pay-off 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 pay-off.


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 pay-off 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 pay-off 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.






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