My broker has been having more and more of hard time locating shares to short for ETF's, specifically UVXY and TVIX. With that said, I came across the synthetic short options strategy that is suppose to mirror a traditional short position. I am trying to figure out how this strategy mirrors a stock short and I don't seem to be grasping the concept. I will outline what I understand at this point with a hypothetical synthetic short: Current price of UVXY is $22 I sell a call of UVXY at a strike of $22 I buy a put of UVXY at a strike of $22 Here are my questions: 1) How does this simulation of a traditional stock short any different than me just buying a put and not selling the call? What is the benefit of selling the call in this situation if all you are getting is the premium if the trade goes your way. While on the other hand, subjecting yourself to "unlimited" risk if the sold call goes against you? What am I missing here...there must be some other benefit to writing the call... 2) What happens at expiration if the buyer does not exercise the call and the price is now $15? What are my options in this situation? And what would be the best option? Any useful info is greatly appreciated
1) You are not missing anything. You wanted to simulate a stock short. Then, you need the simultaneous long and short position to simulate the stock position. And, you need to offset some of your put option premium costs. Compare the pnl graphs for a naked put and a risk reversal (synthetic). That explains what you are trying to understand. In addition, however, the put and call strike selection may provide you an additional advantage if structured to take advantage of the skew. 2) The call expires worthless. The put, which is in the money, makes a profit.
If the call expired worthless wouldn't I keep the premium? Also, someone was telling me that if the buyer of the call never exercised the call in this situation, and if I told my brokerage account not to close it on expiration that the short shares would roll into the next month or something? What happens if the call is out of the money for the buyer on expiration and they do not exercise it? What will my broker do? What choices do I have?
Yes. The term is assigned. You would be assigned the short shares if your put is in the money. The call is out of the money it is worthless. You answered that question already.
Whenever you receive premiums from an option transaction your max profit happens when the option expires worthless, since you keep the premiums. Whenever you pay premiums your max risk happens when the option expires worth less since you lose the premiums. A buyer of an option will normally not execute if out of the money... there are a few corner cases with options trading in the money by a very small margin where a buyer can choose to exercise the option only to see it settle out of the money... but these are not normal. On the other hand, brokers are required to exercise options that are in the money at expiration automatically.
A few more things to consider. Instead of doing a combo (long put, short call of same strike) to replicate short stock in a hard to borrow situation, consider simply buying a deep in the money put where the call is around zero. This way you will not have to sell out the call. The problem with doing the full combo is that when the call is in the money, you will be at a fairly great risk of early assignment. This is because the holder of the call may need long stock himself. The "cost" of the short stock will be written into the options as well. Normally the combo will trade at parity to the stock, less cost of carry or potential dividends. In a hard to borrow stock there will be a premium, depending on how hard to borrow it is. Deeper in the money puts that might normally trade around parity will be trading with a premium.