Synthetic Swing Trading with Option Spreads

[emilov]

Well, how you call it depends in where you learned it . Still, the idea is appealing, to reap higher rewards than with a straight call, less time decay and still a limited risk AAND the higher flexibility to massage the trade should it not kick ass, as it should.

The downside is much higher brokerage, especially for smaller trades.

 

[mazzatelli1000]

Well, how you call it depends in where you learned it . Still, the idea is appealing, to reap higher rewards than with a straight call, less time decay and still a limited risk AAND the higher flexibility to massage the trade should it not kick ass, as it should.

The downside is much higher brokerage, especially for smaller trades.

A Synthetic long is not the same as a reverse collar - your delta exposure would be different for starters - hence risk is different. A risk graph would clarify it.

I don't think you understand my point. Your first example as I understand it IS a long call.

 

[emilov]

I find that there is always a HUGE difference between a synthetic and the real thing. Synthetic long stock does NOT equal buying the stock at all. Your leverage is so much bigger! Even if my example is a synthetic long call, and the graph looks the same, it brings more cash to the table: the call makes money and the bull put makes money at the same time.

I understand the difference between doing the synthetic long stock and collar (the latter, as you describe it looking similar but with a "dent" in the graph). I like to think different terms, out of the money options (rev. collar) will yield better results if the move blows past their strikes, but it takes more time for the stock to get there. At the money (synth long stock) will react faster and profits can be gathered quicker.

 

[mazzatelli1000]

I find that there is always a HUGE difference between a synthetic and the real thing. Synthetic long stock does NOT equal buying the stock at all. Your leverage is so much bigger! Even if my example is a synthetic long call, and the graph looks the same, it brings more cash to the table: the call makes money and the bull put makes money at the same time.

So now put call parity doesn't hold in your world?

The synthetics will not be exact, but no HUGE discrepancies as you suggest
If there were you would arb it away!!!! Why bother with a convoluted spread

And risk graphs that are identical are not ....identical?

Using QQQQ
QQQQ is currently $35.56

The 35/36 Bull put spread is going for $0.44 credit and the $36 call costs $0.51 - TOTAL = Net debit of $0.07, margin requirement is $100
Total risk = $107

The 35 long call = Net debit of $1.08 = total risk = $108

You are adamant that the payoff is DIFFERENT because "the call and the bull put wins"

Let's say at expiration QQQQ finishes at $40
Your bull put spread will earn the full $0.44, while the call will be ($40 - 36) $4
Therefore $4.44 profit less the cost of the call ($0.51) = $393

The 35 long call will be worth ($40 - $35) = $5 profit less the net debit ($1.08) = $392

You forget that the long call itself already has intrinsic value

I understand the difference between doing the synthetic long stock and collar (the latter, as you describe it looking similar but with a "dent" in the graph). I like to think different terms, out of the money options (rev. collar) will yield better results if the move blows past their strikes, but it takes more time for the stock to get there. At the money (synth long stock) will react faster and profits can be gathered quicker.

First you said

You are correct, sold put & bought call => synthetic long (also called a reverse collar) .

Then you say

I understand the difference between doing the synthetic long stock and collar.

So are they different or not?

Prices as follows

 

[mazzatelli1000]

Right or wrong, it just goes to show that high level dissection is important!!
Getting into positions that one thinks is superior and full proof turns out to be dissected to one basic position that you would otherwise not get into - Thank you Cottle!!!

I was spammed this in my email earlier today
Maybe it is the answer we have been looking for

http://www.master*s*oequity.com/
Remove asterixes if you want to visit the site.
It seems to be the norm when searching for swing trading using options - all spruikers

 

[wayneL]

Thank you Cottle!!!

He da man!

Position dissection rules! OK!

I find that there is always a HUGE difference between a synthetic and the real thing. Synthetic long stock does NOT equal buying the stock at all. Your leverage is so much bigger!

You misunderstand the meaning of synthetic. Synthetic equivalence has nothing whatever to do with margin needed, cost or capital employed, and everything to do with the risk reward profile. In that sense, buying a call and selling the equivalent put, once dividends and cost of carry is accounted for, is precisely the synthetic equivalent of long stock, otherwise an arbitrage opportunity exists.

The only difference, assuming put/call parity (99.999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999% of the time), is contest risk. i.e. commission and spread.

I understand the difference between doing the synthetic long stock and collar (the latter, as you describe it looking similar but with a "dent" in the graph). I like to think different terms, out of the money options (rev. collar) will yield better results if the move blows past their strikes, but it takes more time for the stock to get there. At the money (synth long stock) will react faster and profits can be gathered quicker.

OK nomenclature confusion here. Regarding the "reverse collar".

First, let us consider what a collar is. It is a limited risk, limited reward strategy. AKA a synthetic bull call spread (or synthetic diagonal spread if different expiries are used). It is called a "collar" because both reward and risk is truncated at the respective strikes.

What is being described here (otm long call/short put has no truncation of risk and reward whatsoever, ergo, it is not a collar of any sort, much less a reverse collar. It is in fact a long "semi-stock". (ref Cottle page 26)

A reverse collar is a synthetic bear put spread involving stock. (eg short stock, short otm put, long otm call).

 

[mazzatelli1000]

I like your/Cottles definition of collar and semi stock - let's use that!!!

There seems to be no consensus on collar/fence/risk reversal definitions

I've seen Baird describe the long semi stock as a bull fence, while a bull/long fence according to Natenberg is the synthetic bull call spread

I took the interpretation of a reverse collar as the reverse of a collar...LOL if that makes sense?!?!

Either way Emilov's statement that the synthetic long and "semi long stock" being the same is like saying "straddle (also know as a strangle)" - I shouldn't be so persistent with this LOL

 

[wayneL]

I like your/Cottles definition of collar and semi stock - let's use that!!!

There seems to be no consensus on collar/fence/risk reversal definitions

I've seen Baird describe the long semi stock as a bull fence, while a bull/long fence according to Natenberg is the synthetic bull call spread

I took the interpretation of a reverse collar as the reverse of a collar...LOL if that makes sense?!?!

Either way Emilov's statement that the synthetic long and "semi long stock" being the same is like saying "straddle (also know as a strangle)"

Indeed.

Nomenclature can be a nightmare.

Here are a couple of quotes from The Hidden Reality

A “fenced” position (+u / + lower strike put and short higher strike call) is best viewed in
its simplest terms, namely, a bull spread. Manage the bull spread by watching either the long call
spread or the short put spread, whichever is more liquid.

Collar is synonymous with ‘caps and floors’, tunnel, barrier, fence or squash, depending on what
market it is traded..

FENCE: An option and stock position consisting of long stock, long an
out-of-the-money put and short an out-of-the-money call, which
emulates a bull spread. Alternatively, a reverse fence can be long stock,
long in-the-money put and short in-the-money call which emulates a bear
spread. All the options have the same expiration date.

Note Cottle also describes the reverse fence (collar) as the synthetic bear spread.

 

[emilov]

Wow fellas, I missed a large portion of the discussion here.

Firstly, a reverse collar, which consists of a bought out of the money call and a sold out of the money put is an unlimited risk (because of the sold put), unlimited profit (because of the bought call) trade, it has nothing to do with a bull call spread (the latter being a bought call and a sold call at a higher strike and limited risk, limited profit strategy).

Secondly, when I say I understand the difference etc., I clarified in the brackets after, that I understood it by your definition. To me, whether you buy call, sell put at the money or slightly out of it, it's the same strategy that I call synthetic long stock (or reverse collar, as per Anthony J. Saliba). So it's a question of definition.

Thirdly, I strongly disagree in synthetic long stock as described by me being equivalent to buying the stock. Even if they have the same graph, and the same absolute payoff, the fact that the options position is so much more leveraged makes all the difference. If I bought any stock I'd have to put a lot of cash in the market and so the cash on cash return is very, very low, not worth it for me as a trader. So, it's again a question of definition. I don't care about theoreticals but only about the fact that such an options trade allows me to go long a stock without having all the cash to actually buy it (and with the added protection of a bought put it even becomes a limited risk, unlimited profit trade). And as I said, leverage is the reason why I am in options in the first place (that and flexibility). Otherwise I'd just be buying (or shorting) stock.

Cheers, Emil

 

[wayneL]

OK Emil.

Your the expert man.

 

[wayneL]

Reverse Collar - As discussed different folks see it as different things.

I prefer the synthetic bear put to be called a collar and the long call/short put be called semi stock.

Why? Because of consistency of understanding.

1. As I said before, a "traditional" collar is called a collar because a it "collars" the price action, putting a floor under losses and putting a cap on profits. It is called a fence for the same reason.
2. It makes sense to me that a "collar" with the adjective "reverse", would still "collar" profits and loss, i.e. limit loss and cap profit, but in reverse. In other words a collar with negative delta rather than positive delta. In other words, a mirror image in the same way that a "reverse" ratio spread (AKA back spread) is the mirror image of a ratio spread.
3. IF we call the short put/long call combo a reverse collar, what do we then call a long put/short call combo (A reverse reverse collar )... what do we call the synthetic bear spread i.e. the reverse fence/collar as defined by God... errrr, I mean Charles Cottle? It then adds to confusion.

That said, others will still use the illogical nomenclature that Emil and others use. It's not a perfect world is it? I guess those of us on the side of logic will have to live with that.

Emil, regarding synthetic long stock. There is not an option professional in the world who would agree with you. You are wrong, afield, amiss, askew, inaccurate, incorrect, mistaken, خطأ, 错误, verkeerd, mal, Unrecht, λανθασμένος, torto, 悪事, 부정, krzywda, erro, неправда and fel.

Leverage is IRRELEVANT when considering synthetic equivalency. Why?

Because synthetic equivalence is about risk profile, not margin/cost.
Some market participants are able to use less margin than others. Not everybody has to cough up the full cost of shares like most retail traders. Research the tern "hair cut" and you'll see what I mean.

Even retail traders have differing margin requirements. My account is big enough to be subject to SPAN margining (AKA portfolio margining). I can enter a covered call under margin rules, for much less than non-SPAN margining. An example is at http://sigmaoptions.blogspot.com/2007/01/new-margin-rules-for-option-positions.html

COVERED WRITE

Position
Long 500 IBM @ $91.25
Short 5 calls IBM APR 95 @ $ 2.78
Strategy margin is 50% of stock less the short option premium or $21,422.50
Portfolio margin requirement is $5,504.00

PROTECTIVE PUT

Position
Long 500 IBM @ $91.25
Long 5 puts IBM APR 90 @ $ 2.50
Strategy margin is 50% of stock plus full payment for put or $24,062.50
Portfolio margin requirement is $1,878.00

NON-CONFORMING DEBIT SPREAD

(Long must expire on or after short)
Position
Long 50 calls IBM APR 90 @ $5.45
Short 50 calls IBM JUL 100 @ $2.28
Strategy margin requires full payment for long option and
appropriate margin on short option position or $74,750.00
Portfolio margin requirement is $14,106.00

Under your assumption. A covered call under strategy margin rules is not the same as a covered call under SPAN margining, because of the leverage. Yet there is no question that a covered call IS a covered call... is there?

That is plainly ludicrous.

 

[wayneL]

Here's another example of synthetic equivalence:

Buy 1 x (lets say stock price is @ $50) $50 call for $2.50
Buy 1 x $50 put for $2.50

Cost of strategy and maximum risk is $500 (using a contract size of 100)

Everybody knows this as a long straddle.

Now consider the following

Short stock @ $50
Buy 2 x calls for $2.50

Cost $5,500 with maximum risk of $500

The second strategy IS A SYNTHETIC STRADDLE. Yet according to Emil's logic, it's not a synthetic straddle at all because of the leverage (or lack thereof).

WTF?

Now, My point about SPAN margining applies here. The straddle costs $500, yes? But under SPAN margining, what's my capital outlay on the synthetic straddle?

Yep! You guessed it! It's $500 because that is maximum risk.

A more clearer destruction of the "synthetic equivalence doesn't count because of leverage" argument, there will never be.

Hence, it is inarguable that long call and short the corresponding put IS a synthetic long.

Once again, leverage is irrelevant to synthetic equivalence.

Amen

 

[mazzatelli1000]

OK Emil.
Your the expert man.

Sure is

http://www.articlesbase.com/finance-articles/beginner-trader-making-50k-in-first-two-months-672473.html

http://www.investing-in-property.com/ - surprised you haven;t make $100K from this and qualify for portfolio margining and trade even more synthetics!!

Looked at the blog, it seems there are others that have already tried to get through to him about synthetics.

Lost cause IMHO

To appear wise, one must talk;
To be wise, one must listen.

Best advice I have been given.

 

[emilov]

Dear Wayne, thanks for keeping the discussion on an objective level, unlike others who chose to get personal just because someone dares to awake the appearance of disagreeing with their views.

A slight comment on SPAN, the ASX and clearing participants use TIMS which is quite different in margin calculation. I've seen tests and ran calculations myself which produced quite a different results. Just fyi, this is irrelevant for this discussion.

It seems like the discussion is going in two directions, definitions and strategy. I will address definitions only shortly, makes no sense otherwise. I've quoted from a book, if you don't agree, complain on the internet, maybe the author will care.

What I definitely like do discuss is option strategies. However you call it a bought call and a sold put, that is synthetically equivalent to long stock, I've never denied that. This is theory to me though, I'm a practitioner who does around 10 trades every month.

In practice if I had 10k to invest, I could buy the stock if I had the view it was going to rise. If the stock goes up by say 5% I've made 5% on my money (excluding brokerage, slippage).

If I implement the trade with options, a synthetic long stock and I was to risk 10k (say stop losses were guaranteed) if the stock goes up by 5% I'll make quite a bit more percentage wise.

This is ALL I'm talking about, nothing else.

 

[warezwana]

Добро пожаловать comrade

ха ха ... теперь ты говорите на языке я понимаю

длиной живет виток, друг.

you just said something like 'long live revolving (as in going around), my friend your translator should have said something like...
'Да здравствует революция, друг!'


But to this Option....

Hey, about that trade. It does make sense to do it like this but there is better. So you are doing a bull call spread and short put (both of which limit you on the upside, but not on the down side).

Why not instead turn it around and do a bull put and a long call. The bull put finances the long call, you have unlimited upside profit but limited loss on the down side. It's a protected collar so to speak.

My 2 cents

Sounds interesting!!! yet complicated Is this best suited to a directional trade rather than sideways?

Emil, regarding synthetic long stock. There is not an option professional in the world who would agree with you. You are wrong, afield, amiss, askew, inaccurate, incorrect, mistaken, خطأ, 错误, verkeerd, mal, Unrecht, λανθασμένος, torto, 悪事, 부정, krzywda, erro, неправда and fel.

Apart from not agreeing on (if I understood it all) leverage on a synthetic trade is this basically a free trade? but the main thing im wondering is how to even try placing something like this wow... got me very curious. placing a spread ok, easy enough but taking on a call or put to the side of it really gets me thinking way too hard.

 

[mazzatelli1000]

Sounds interesting!!! yet complicated Is this best suited to a directional trade rather than sideways?

That has already been dissected/simplified into a long ITM call.
Directional: bullish bias

 

[wayneL]

you just said something like 'long live revolving (as in going around), my friend your translator should have said something like...
'Да здравствует революция, друг!'[/B]

Damned English homonyms (Complaint letter fired off to systransoft.com)

But to this Option....
Sounds interesting!!! yet complicated Is this best suited to a directional trade rather than sideways?

You have to read the ensuing posts. As Mazza pointed out, it dissects into an ITM long call. So just buy the call to save on commisions... same trade.

If people would only use a model, such as Hoadley's software, or use position dissection, it would be immediately apparent.

Apart from not agreeing on (if I understood it all) leverage on a synthetic trade is this basically a free trade? but the main thing im wondering is how to even try placing something like this wow... got me very curious. placing a spread ok, easy enough but taking on a call or put to the side of it really gets me thinking way too hard.

There is no such thing as a free trade. Even if there is no nett debit or credit, there is still margin to put up. Risk is always best measured by the Greeks.

Complicated, multilegged positions can be fun and there are unlimited possibilities. But they need to suit specific goals rather than be an end in itself.

 

[emilov]

What wayne means is that when you buy options that you offset by selling other options you might not incur a debit (you might even get away with a credit). This still means that the clearing participant will charge you heaps of margin for the sold option (because it is uncovered, or naked). This margin is a security deposit they will withdraw from your trading account (but it can be covered with stock too). The margin will variate as the stock price fluctuates. If the stock price moves unfavorably to you and your margin increases beyond the amount of your collateral you'll get a margin call from the broker wanting you to put more money into the trade (or close it). If you don't you'll be closed out.

To all the mathematicians in this thread, you are saying that a bull put plus call is like a straight ITM call, yes? What strikes are we talking about please? I genuinely want to know this, so please remain constructive if possible.

Because I did test it in practice as I trade very actively. I compared a bull put spread, a straight call and the above trade. Here are the results (the LGL trade). LGL on that day was at 2.68 (the 16th, not 15th as it says). Even though they were closed on different days (the call earlier) the price of the underlying was similar, around 2.95 (yeah should have let it run a bit more, I know ). Based on your theory the straight call and the protected strategy from above should yield similar results (the complex strategy should have been even worse because of 6 more days time decay), but they don't, the protected one yielded much better profits (percentage wise, similar capital at risk, number of contracts differs of course) in the example I'm providing.

This is why I want to know, what strikes are we talking about (could you refer to my example)?

 

[wayneL]

To all the mathematicians in this thread, you are saying that a bull put plus call is like a straight ITM call, yes? What strikes are we talking about please? I genuinely want to know this, so please remain constructive if possible.

If the bought call is correspondent (ie same strike and expiry) to the short put (as discussed previously), you have a synthetic long. Because you have a bought put at a lower strike, what you have is a protective put strategy i.e. Long stock (synthetically) plus a long put.

A protective put strategy is a synthetic long call at the strike of the long put.

So when it all boils down you have a long call at the lower strike.

Because I did test it in practice as I trade very actively. I compared a bull put spread, a straight call and the above trade. Here are the results (the LGL trade). LGL on that day was at 2.68 (the 16th, not 15th as it says). Even though they were closed on different days (the call earlier) the price of the underlying was similar, around 2.95 (yeah should have let it run a bit more, I know ). Based on your theory the straight call and the protected strategy from above should yield similar results (the complex strategy should have been even worse because of 6 more days time decay), but they don't, the protected one yielded much better profits (percentage wise, similar capital at risk, number of contracts differs of course) in the example I'm providing.

This is why I want to know, what strikes are we talking about (could you refer to my example)?

Emil,

1/ This is what you traded.

Example 1 - FEBRUARY 2.50 long call

Example 2 - JANUARY 2.50/2.75 bull spread

Example 3 - Synthetic JANUARY 2.50 long call with one long call component (the 2.75) exited early.

Example 3 could have been constructed by simply going the long call, shorting the 2.75 call on 23/1, which morphs it to a 2.50/2.75 bull spread.

2/ As the 3rd trade was morphed, it cannot be directly compared to the other two.

Edit to Add: Emil! I thought the figures stunk, but I missed something very important. You're comparing a February expiry (the natural long call) with a January expiries (the vertical and the synthetic long call)

APPLES AND ORANGES!!!!!!!

 

[emilov]

Ahh thanks for clarifying wayne, now I see my "mistake" too. Next time I do this I'll try matching months (and strike as you suggested). But hey, it's a good mistake to make, right, if it makes more money?