Synthetic Short Futures
synthetic short futures (split strikes)
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 Category: synthetic futures and option strategies
 Published on Thursday, 18 February 2010 01:00
synthetic short futures (split strikes)
the synthetic short futures (split strikes) is a less aggressive version of the synthetic short futures.
the synthetic short futures (split strikes) position is created by selling slightly outofthemoney calls and buying an equal number of slightly outofthemoney puts of the same underlying futures and expiration month.
synthetic short futures (split strikes) construction

sell 1 out the money call

buy 1 out the money call

the split strike version of the synthetic short futures strategy offers some upside protection. if the trader's outlook is wrong and the underlying futures price rises slightly, he will not suffer any loss. on the flip side, a stronger downward move is necessary to produce a profit.
profits and losses with a split strike strategy are also not as heavy as a corresponding short futures position as the strategist has traded some potential profits for upside protection.
unlimited profit potential
similar to a short futures position, there is no limit to the maximum possible profit for the synthetic short futures (split strikes). the options trader stands to profit as long as the underlying futures price goes down.
the formula for calculating profit is given below:
 maximum profit = unlimited
 profit achieved when price of underlying < strike price of short call + premium received or price of underlying < strike price of long put  premium paid
 profit = strike price of long put  price of underlying +/ premium received/paid

unlimited risk
like the short futures position, heavy losses can occur for the synthetic short futures (split strikes) if the underlying futures price makes a sharp move upwards.
often, a credit is usually taken when establishing this position. hence, even if the underlying futures price remains unchanged on expiration date, there will still be a profit equal to the initial credit received.
the formula for calculating loss is given below:
 maximum loss = unlimited
 loss occurs when price of underlying > strike price of short call + premium received or price of underlying > strike price of long put  premium paid
 loss = price of underlying  strike price of short call +/ premium paid/received + commissions & fees
breakeven point(s)
the underlier price at which breakeven is achieved for the synthetic short futures (split strikes) position can be calculated using the following formula.
 breakeven point = strike price of short call + premium received or strike price of long put  premium paid
example
suppose june crude oil futures is trading at $40 and each contract covers 1000 barrels. an options trader enters a splitstrikes synthetic short futures position by buying a jun 35 put for $2000 and selling a jun 45 call for $2200. the net credit received when entering the trade is $200.
scenario #1: june crude oil futures falls slightly to $35
if june crude oil futures drops to $35 on expiration date, both the long jun 35 put and the short jun 45 call will expire worthless and the trader keeps the initial credit of $200 as profit.
scenario #2: june crude oil futures crashes to $20
if the price of june crude oil futures falls dramatically to $20, the short jun 45 call will expire worthless while the long jun 35 put will expire in the money and be worth $15000. including the initial credit of $200 received, the options trader's net profit comes to $15200. comparatively, a corresponding short futures position would have achieved a greater profit of $20000.
scenario #3: june crude oil futures rallies to $60
if the price of june crude oil futures has instead surged to $60 on option expiration date, the short jun 35 put will expire worthless while the long jun 45 call will expire in the money and be worth $15000. buying back this long call will require $15000 and subtracting the initial $200 credit received when entering the trade, the trader's net loss comes to $14800. a heavier loss of $20000 loss would have been suffered by a corresponding short futures position.
commissions
for ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.
however, for active traders, commissions can eat up a sizable portion of their profits in the long run. if you trade options actively, it is wise to look for a low commissions broker. traders who trade large number of contracts in each trade should check out optionshouse.com as they offer a low fee of only $0.15 per contract (+$8.95 per trade).
Please be aware that trading futures and options involves substantial risk of loss and is not suitable for all investors.
Past performance is not necessarily indicative of future results.
A DIVISION OF FOURTH RIGHT COMMUNICATIONS, L.L.C.
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