Synthetic futures Article question

Discussion in 'Options' started by asdfghj7, Dec 26, 2008.

  1. The following is from investopedia. My question is below the paragraph in quotes.

    Types of Synthetic Futures
    "There are two types of synthetic futures, a synthetic long and a synthetic short.
    A synthetic long entails two transactions: purchasing an at-the-money call option, and selling an at-the-money put. For example, if the gold market was at $960 and you felt that it was going to $1,000, to trade the futures outright you would have to put $4,725 in margin (common margin requirement). The options on this same contract are a lot less. For example, an at-the-money $960 call is priced at $2,710, and an at-the-money put is priced at $2,500.
    By purchasing the call outright, you immediately benefit from a $2,015 savings over having to put in $4,725 for the futures margin. A synthetic long is created by taking the process one step further - selling the at-the-money put for $2,500. This brings your total cost for the call down from $2,710 to $210 (the amount paid, minus the collected premium: $2,710 - $2,500 = $210 spent). So, while putting on the outright futures would have cost you $4,725 up front, the same position as a synthetic long would cost you only $210. That's a savings of $4,515.
    A synthetic short is just the opposite - you purchase an at-the-money put and sell an at-the-money call. Let's take the same gold example. The market is at $960 and you decide to purchase an at-the-money $960 put for $2,500. By purchasing the put outright you have a savings of $2,225 over the futures. By taking the process one step further and selling an at-the-money call for $2,710, you turn your position into a synthetic short. This actually makes the put you bought cost nothing, and adds an additional $210 to your account (the amount paid, minus the collected premium: $2,500 - $2,710 = $210 profit).
    Pros and Cons
    So, if you decide to take advantage of a synthetic long position it would cost you only $210, and if you decide to take advantage of a synthetic put position it would cost nothing. This is a big difference from the required $4,725 you would have to have as margin if you decided to trade a futures contract by itself.
    With synthetic futures as with everything else, there is still plenty of opportunity for loss. While it may cost less to place the position, you are still exposed to the same unlimited loss that's typical of an outright futures position. The question you have to ask yourself is whether it's more feasible to risk a few hundred dollars on the position or put up several thousand. Depending on your answer, the tools you would use to protect yourself from losing it all in a futures position are the same tools you would use in a synthetic futures position: stop-loss orders, limit orders and protective options. There are subtle and few differences in their execution. (To learn more, red Money Management Matters In Futures Trading.)"

    I tried this out on the ES for March in the IB demo. I bought an ATM call and sold an ATM put. The price of each was pretty much the same. The margin came out to be around $5500, which is no different than just buying a contract. I'm missing something but I don't know what it is. What I'm reading into his article is that the normal margin can be drastically reduced. IB didn't show any difference as far as how much money I had to put. Would someone explain this please.
  2. Carl K

    Carl K

    "(To learn more, red Money Management Matters In Futures Trading.)"
    I can't answer for the author's article and I have not read it.

    I believe trading margin is associated with risk of loss to your account.
    The risk of a Long Future or Synthetic of the same, is to the downside. (The Short naked Put)
    The risk of a Short Future or Synthetic of the same, is to the upside. (The Short naked Call)
    I believe IB will protect itself from trading risk and require enough margin in an account.

    I'm pleased you are asking and learning, rather than losing money. (The expensive education)
    I hope this simple of an answer addresses your question.

  3. Carl is correct, in your example or the example the author uses you/he didnt make any mention for the margin in holding the short option leg of the synthetic future. They dont allow you to take unlimited risk via short options with no margin.
  4. 1) There's no "free lunch" with that trade.
    2) Options will have wider bid-ask spreads than the futures resulting in more slippage.
    3) If the "cheap" synthetic were available, you could buy it and then hedge it with the underlying futures for "free money".
    4) It's better to consider synthetic futures when the underlying futures are locked-limit.
  5. No one is going to make you a reasonable bid.offer spread in the options if the futures are limit up or down.