Trading Options  |  MAY 2006

Synthetically Speaking by Paul J. Kluskowski

Stocks & Commodities V. 24:5 (16-20): Synthetically Speaking by Paul J. Kluskowski How do you transform your premium from debit to credit? Think synthetic positions. Ask anyone in the know and they will tell you that the risk/reward profile of a long option is limited risk with unlimited reward potential. The built-in assumption is that the premium is at risk. What if there was a way to change this? What if the premium could be transformed from debit to credit, leaving you with a risk/reward spectrum that was small gain to unlimited gain, versus small loss to unlimited gain? Impossible, you say? If you can think synthetically, this transformation is quite possible. WHAT ARE SYNTHETIC POSITIONS? Synthetic positions are combinations of stock or futures and options that give the risk/reward profile of a different tradable. Using synthetic positions gives us nearly limitless possible combinations, but our focus right now is to create a synthetic long call option for a credit. A long call option can be synthetically replicated with the use of a long stock position with a long put. (I should note here that there is limited downside risk with hypothetically unlimited upside reward.)

by Paul J. Kluskowski