The Importance of Understanding Synthetics?

Discussion in 'Options' started by sync, Nov 29, 2008.

  1. sync


    I keep reading about the importance of understanding synthetics. What is an example of how knowing synthetics is useful if I don't trade the underlying?
  2. dmo


    If you're trading options, I personally think it's important to have conceptual agility in understanding and visualizing how options work - how all the pieces of the puzzle fit together. Understanding put/call parity and synthetics (they go together) is an essential part of that. Without it you're trading with one arm tied behind your back - you'll look at your position and fail to see all the possibilities, including the one that might put your position back on track.
  3. It's beneficial even at the elementary level:

    For example, why write covered calls when you can sell the naked put instead (one commission instead of two).

    Why own a collar with the awkward 3 legs when you can sell a put spread or buy a call spread?

    DMO is correct. the more you understand the better, but even if you believe in keeping things as simple as possible, knowledge is power (and in this case, money).

  4. sync


    Who does a good job of explaining this area? I have Cottle's first book and his writing style doesn't match up with how I process information.
  5. sync


    Thanks Mark. I have a basic understanding of the synthetics and put/call parity. Your link mentions a covered call being equivalent to a naked put. I knew about that and that is why I prefaced my question with asking about the advantage of knowing this stuff if I'm not trading the underlying.

    I understand the basic theory but I don't see how it is applicable to trading apart from exploiting some minor arbitrage opportunity that may occasionally exist.
  6. spindr0


    If your option trading is fairly simpe, chances are, you have little or no need to understand synthetics. But if your positions get a bit more complex, it's helpful to understand equivalents because it can save you extra commissions and slippage if you can execute a position with fewer legs.

    Mark gave the example of a covered call being equal to naked put. That's probably the most common synthetic for local traders. Occasionally, someone pops up with the idea of a complex strategy using a guts strangle (put strike higher than call strike). The large premiums seem to attract the flies to the lights (g). The same can be achieved with the same strike OTM strangle with less complication from early assignment or margin issues (depending on whether long or short).

    It's not critical to understand synthetics but it can be helpful when you get into the deeper end of the pool.
  7. I'm on and not finding any search results which directly address synthetics. Any new book suggestions.

    I suppose synthetics is not the ultimate destination I'm after as all synthetics can be arrived at mathematically, but I would like to know more about popular and frequently used moves for position adjustments by the pros.

  8. MTE


    Check out this one and this one.
  9. Nanook


    Options as a Strategic Investment (3rd Edition)
    Larry McMillan

    Chapter 21 (pg. 301-308)
    Synthetic Stock Positions Created by Puts and Calls
    "Synthetic Long Stock"
    "Synthetic Short Sale"
    "Splitting the Strikes" (Bullishly Oriented/Bearishly Oriented)

    Google: Synthetic Options

    Synthetics can be placed as a stand alone position; legged into; or "morphed". Just like any other strategy (pretty much). The "market/position" is always dynamic... go with the flow~~~...
    #10     Dec 9, 2008