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- Synthetic Longs: Navigating Market Shifts with Alternative Strategies
Synthetic Longs: Navigating Market Shifts with Alternative Strategies
Weekly Edition: February 12th, 2025
News Snapshot
Trump Slaps a 25% Tariff on Steel and Aluminum – Automakers Brace for Impact
Gold Prices Take Off – Investors Seeking a Safe Haven or Just Really Into Shiny Things?
Inflation Data Drops Today – Expected to Show Prices Climbing... Just a Bit Slower
Jerome Powell’s Testimony Tour: Senate Yesterday, House Today – Will He Say Anything New?
TL;DR
President Donald Trump has announced a 25% tariff on steel and aluminum imports, effective March 12, 2025, aiming to protect U.S. industries. Automakers, however, are less than thrilled—after all, it’s hard to drive profits when the cost of making cars goes through the roof. Some industry leaders joke that at this rate, the most affordable new vehicle might be a bicycle. Despite sourcing most materials from North America, the global nature of supply chains means the tariffs could still significantly impact production costs, leaving car manufacturers feeling like they just got rear-ended. In response to these tariffs, gold prices have surged, driven by fears of trade wars and geopolitical uncertainties. Investors are flocking to gold as a safe-haven asset, proving once again that when things get rocky, nothing shines brighter than a good old-fashioned gold bar.
Meanwhile, the January Consumer Price Index (CPI) report is expected to show that headline inflation eased slightly, with consumer prices projected to rise by 0.3% over the prior month, down from December’s 0.4% increase. While a slowdown is welcome news, it’s not exactly cause for celebration—prices are still climbing, just at a slightly less painful pace. The report will be closely watched as it could influence the ongoing debate over potential interest rate cuts by the Federal Reserve. Federal Reserve Chair Jerome Powell, in his recent testimony to Congress, emphasized patience regarding rate adjustments, stressing the importance of waiting for clear data before making any moves. While some are eager for rate cuts, Powell made it clear the Fed won’t be rushing into anything—because when it comes to interest rates, slow and steady wins the race (or at least avoids a policy misstep).
“Good-To-Know’s”
Synthetic Positions - A synthetic position is a trading strategy that uses a combination of options to replicate the payoff of another position, typically involving the underlying asset, without actually owning it. For example, a synthetic long position mimics stock ownership using options, while a synthetic short position can replicate a short stock position using options as well. By combining various call and put options at different strike prices and expirations, synthetic positions allow traders to gain exposure to price movements with less capital outlay, greater flexibility, and the ability to customize risk and reward profiles.
Thought Throttle
What if you could go long on a stock without draining your all available capital? Well, you certainly can replicate stock ownership using options—allowing you to control the stock with less capital and more flexibility. It can be done with a two-leg option strategy called a synthetic long.
With a synthetic long position, you buy a call and sell a put at the same strike price. In a lot of cases, the put sold will not be a Cash-Secured Put, but a Naked Put. This is normally done to keep as much capital free as possible.
This strategy mirrors the risk-reward profile of owning the shares of stock but can suit the investor’s motivation of not having to hold the stock.
For example, let’s look at SPY, the S&P 500 ETF.
To buy 100 shares of SPY, you would need $60,525 ($605.25 * 100).
However, if you wanted to enter a synthetic long by buying the ATM call and selling the ATM put, your required margin would only be ~$12,080 (Margin requirements depend on the brokerage and the volatility of the underlying; this is a rough estimate).
This trade would result in a net debit of $2.45. The profit and loss for the synthetic long would be very similar to the Long position, but you would not tie up as much cash. You would also have to see a movement in the underlying to cover the debit (You start the position at $2.45 below your breakeven).
In this example, because of the net debit, the break-even for the long synthetic would be $607.45, but the break-even for the purchase of 100 shares would just be the 605 purchase price (Doesn’t include commissions or fees).
If you want to play around with the numbers (highly recommended), you can visit OptionStrat and use their ‘build’ tool.
There are a few key differences to note before entering into a synthetic long position:
Feature | Holding the Stock | Synthetic Long Position (Call + Short Put) |
|---|---|---|
Capital Requirement | Full stock price per share | Lower initial capital (only premium/margin needed) |
Expiration | No expiration, hold indefinitely | Options have expiration, requiring active management |
Dividends | Eligible for dividends | Not eligible for dividends |
Voting Rights | Has voting rights | No voting rights |
Leverage | No leverage (unless using margin) | Built-in leverage due to options structure |
Downside Risk | Full downside risk of stock | Same downside risk as stock |
Upside Potential | Full upside potential | Same upside potential as stock |
Margin Requirement | None (if buying outright) | Margin Requirement, especially for the short put |
Assignment Risk | None | Short put has assignment risk |
Liquidity | High (can be sold instantly) | May be less liquid depending on Make underlying selected |
Timeline | Can hold as long as desired | Must roll or close position before expiration |
Trading Costs | May have a commission on purchase and sale | Usually incurs commissions on both options, plus bid-ask spread costs |
Call vs. Put Premiums | N/A | Calls often have higher premiums than puts, typically leading to a net debit |
If you're considering adding synthetic long positions to your trading strategy, start by testing the setup in a paper trading account to understand how it behaves under different market conditions. Before executing, evaluate key factors such as implied volatility, margin requirements, and assignment risk on the short put.
Unlike owning shares outright, which you can hold indefinitely, a synthetic long position has an expiration date, meaning you must actively manage the position or roll the contracts forward to maintain exposure. Since this strategy mimics stock ownership, ensure it aligns with your risk tolerance and market outlook.
With the right approach, synthetic long positions can be a powerful tool for gaining leveraged exposure while keeping capital available for other opportunities. Make sure you research further and understand the trade before entering the position.
Relevant Quote I Like
"It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong."
Throttle Q&A
Reasons to avoid holding the stock?
Tax considerations: Holding the stock may be less advantageous for tax purposes, especially with precious metals, which can be subject to collectible taxes. A synthetic long position can help avoid this.
Avoiding Disclosures: In some cases, ownership of the stock involves disclosures and documentation. Synthetic Longs can mitigate the required disclosures/compliance related to stock ownership.
Interest charges: Stocks used as margin collateral incur interest charges, adding to the cost of holding the position.
What is the maximum profit of a synthetic long position?
The maximum profit is unlimited. As the price of the underlying asset rises, the long call gains value, and since there's no cap on how high the stock price can go, the potential profit is theoretically infinite. The short put does not limit the upside.
What is the maximum loss?
The maximum loss occurs if the stock price falls to zero. If the stock price drops to zero, the investor loses the strike price per share (x100) plus the initial net debit paid.
How do you calculate the breakeven point?
The breakeven is calculated by adding the strike price of the call option to the net debit paid (or subtracting the net credit, if applicable). For example, with SPY, the breakeven would be $607.45 ($605 strike + $2.45 net debit).
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Disclaimer
The information provided in this newsletter is sourced from reliable channels; however, we cannot guarantee its accuracy. The opinions expressed in this newsletter are solely those of the editorial team, contributors, or third-party sources and may change without prior notice. These views do not necessarily reflect those of the firm as a whole. The content may become outdated, and there is no obligation to update it.
We strongly advise you to consult with a financial advisor before making any investment decisions, including determining whether any proposed investment aligns with your personal financial needs.
