Archive / Investment Adviser (Level 1) / Understanding Derivatives

nism-series-xa-synthetic-long-stock-options-construction[ INVESTMENT ADVISER (LEVEL 1) ]

How is a 'Synthetic Long Stock' position constructed using equity options?

[ A ]Buying 100 physical gold bars.

[ B ]Buying a put and selling a call.

[ C ]Selling all portfolio equities and holding cash.

[ D ]BUYING an At-the-Money Call Option and simultaneously SELLING an At-the-Money Put Option at the same Strike Price and Expiry Date (Synthetic Long = Long Call + Short Put).[ CORRECT ]

Takeaway

A Synthetic Long Stock position is built by buying an ATM Call and simultaneously selling an ATM Put at the same strike price and expiry, replicating the payoff of owning the underlying stock outright.

Derivation

This construction works because of put-call parity: a long call gives unlimited upside above the strike, and a short put creates unlimited downside exposure below the strike (since the writer must buy the stock at the strike if assigned) — combined, the position's delta is effectively 1.0, moving roughly rupee-for-rupee with the underlying stock, just as physical share ownership would. Traders use this synthetic structure instead of buying the stock directly to reduce upfront capital outlay (the two option premiums often roughly offset) or to access margin/leverage benefits of the derivatives market, while accepting the same risk profile as outright stock ownership.

Why the others fail

A — Buying 100 physical gold bars.

A physical commodity like gold bars has no relationship to constructing an equity payoff profile using listed options on a stock's strike price and expiry.

B — Buying a put and selling a call.

Buying a put and selling a call creates a Synthetic Short Stock position (delta approximately -1.0), the mirror-image opposite payoff of the Synthetic Long Stock the question asks about.

C — Selling all portfolio equities and holding cash.

Liquidating all portfolio equities into cash removes market exposure entirely, which is the opposite of replicating stock-like exposure through a synthetic long options structure.