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I am having trouble understanding the following synthetic relationship:
Synthetic long put option = Short underlying + long call

Now, if XYZ is at 40, and I short XYZ at 40 and also purchase the 40 call, then:

Short position benefits if underlying goes down, but the long call loses value at the same time. So do I really want the underlying to go down? What exactly should the underlying do for this position to work in my favor? In a long put, I want the underlying to go down, but here I am not able to come to a conclusion.

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A long put - you have a small initial cost (the option premium) but profit as the stock goes down. You have no additional risk if the shock rises, even a lot.

Short a stock - you gain if the stock drops, but have unlimited risk if it rises, the call mitigates this, by capping that rising stock risk. The profit/loss graph looks similar to the long put when you hold both the short position and the long call.

You might consider producing a graph or spreadsheet to compare positions. You can easily sketch put, call, long stock, short stock, and study how combinations of positions can synthetically look like other positions. Often, when a stock has no shares to short, the synthetic short can help you put your stock position in place.

  • Thanks. My confusion is: in a long put,I want stock to go down. But in the synthetic, if stock goes down, short position gains but the long call loses. I guess the position overall still gains because it has -50 deltas. – Victor123 Mar 7 '15 at 16:16
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    The long call is not a moneymaker, it's to protect you from losing a lot if the stock goes up instead of down. Mimicking the nature of a put when combined with a short. Your confusion is understandable, options are not a simple thing to understand. – JoeTaxpayer Mar 7 '15 at 16:19
  • Thank you. Got your point now. I guess if we think in terms of deltas, it makes more sense to me. – Victor123 Mar 7 '15 at 16:30

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