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Synthetic Options

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Synthetic options are operations that mimic options, like a Put or a Call. Due to the low liquidity of Puts at BM&F, it is possible to mimic a sale or purchase of a Put, using the underlying asset and a Call. Separately, they are still a cash asset and a Call, but used together they can emulate the behavior of a Put based in that same underlying asset. Put prices in the Market, though, must be the same as synthetic position’s (excluding transaction costs and taxes), because if not the same price, you could arbitrate prices, buying synthetic position on one side and the other available selling, making profits without risk..

Buying a Call

To buy a synthetic Call, it is necessary to buy the underlying asset in cash and a Put option. Graphically, results figure as follows:

Asset Purchased

 Compra Ativo

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Put Purchased

gráfico Long Put_clean

 =

Synthetic Call Purchased

gráfico Long call_clean

Results: the purchase of the asset may lead to unlimited gains or losses, if prices hike or drop, respectively. Buying a Put, on other hand, may lead to unlimited gains if prices drop, but to limited losses if prices increase. Thus, final results work as if you bought a Call – if prices drop, losses are limited, as losses from the asset are almost nullified by the Put that has been purchased, excluding the premium paid. If share prices hike then profits from the Asset exceed the limited losses from buying a Put (premium), which results in a “synthetic” Call.


Selling a Call

Selling a synthetic Call involve both selling the underlying asset and selling a Put. Graphically, that can be represented as follows:

Selling the Asset

 venda ativo

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Selling a Put

gráfico Short Put_clean

 =

Selling a synthetic Call

gráfico Short call_clean

Results: selling the asset upfront leads to unlimited gains if prices drop and unlimited losses if that increases. Selling a Put, however, results in limited profits if prices increases, including the premium to be received, otherwise it leads to limited losses if the asset price drop. Thus, it works just like selling a Call – if prices drop, profits are made by the premiums received from selling a Put. If prices increase, losses can be unlimited, as the asset itself will lead to dramatic losses, while the Put sold will pay only a tiny premium, and that results into a synthetic Call sold.


Buying a Put

Buying a synthetic Put envolve selling the asset upfront and buying a Call. Graphically, that can be represented as follows:

Selling the Asset

venda ativo

+

Buying a Call

gráfico Long call_clean

=

Buying a synthetic Put

gráfico Long Put_clean

Results: selling the asset cash results in unlimited gains if prices drop, and unlimited losses if it hikes. Buying a Call will produce unlimited profits if share prices are up, and a limited loss if the asset price falls, being the premium paid for the purchase of Call. So the end result will be the same as if you bought a Put, that is, if the asset price falls, there will be a limited loss, being the premium paid for the purchase of the Call. If the asset price falls, the unlimited earning assets in cash outweigh the limited losses (premium) to purchase the Call, resulting in a purchase of a synthetic Put.


Selling a Put

A synthetic Put sale comprises both buying the asset upfront and selling a Call. Graphically, that can be shown as follows:

Buying the asset

Compra Ativo

 +

Selling Call

gráfico Short call_clean

=

Selling a synthetic Put

gráfico Short Put_clean

Results: buying the asset upfront lead to unlimited gains if prices increase, and unlimited losses if that drops. By selling a Call, limited profits can be made if the asset’s prices drop, being the premium received, and will have an unlimited loss if the asset price rise. The whole operation works as a Put sold – if prices drop, losses can be unlimited, with losses from buying the asset exceeding the premium received by selling a Call. Otherwise, gains will be limited, being the premium received from selling the Call, which altogether results into a synthetic Put sold.

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