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What are some practical applications of synthetic option positions for a retail trader? One can always memorize synthetic relationships. But how does understanding a synthetic relationship help the trader. A synthetic may have a lesser margin requirement and in cases, may require a lesser capital outlay.

But beyond that, do understanding of synthetics provide any edge to the retail trader? I am not talking of market makers who can use synthetics to extract small arbitrage profits.

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Synthetics can offer advantages to the retail trader trying to mask their intentions.

If you have ever taken a position in the market and then the market suddenly moves in reverse, there are market participants that are able to cause this reaction. Even though you consider your tiny purchase to be insignificant amongst institutional traders. But every trade effects the market. So you should understand masking your intentions.

For example you may open a call (or lots of calls) but suddenly the market starts moving against you drastically, as if someone was trying to cause a loss in your account. Instead you can construct a synthetic long call by purchasing the shares and an at the money put. This is just an example, as usually more complex strategies give away your intentions.

A successful retail trader may eventually find that they are a large market participant, especially in the less liquid options market. You have to understand at this point, that large options trades are announced on TV and on newswires. You don't want to give away your intention.

Then it becomes hard to deduce if you are bullish, or bearish, or hedging an existing position, or anything else.

  • Thanks. Can I ask you personal definition of a less liquid market? Is it <100 contracts a day for ATM options for the front month? – Victor123 Mar 13 '15 at 16:52
  • "For example you may open a call (or lots of calls) but suddenly the market starts moving against you drastically, as if someone was trying to cause a loss in your account." That is something I've wondered about. If you buy calls, another person took the opposite position by selling those calls. How does that "someone" decide who to inflict the loss on by moving the market? – pacoverflow Mar 13 '15 at 17:16
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    @pacoverflow It is usually a different market participant, not the person on the other side of your trade. This person can decide based on if the trade was opened closer to the ask, or if it was opened closer to the bid. The reason is that there are a lot of overleveraged market participants that can't withstand much losses and will be forced to close their position at a bad price (but good price for the loss inflictor) – CQM Mar 13 '15 at 17:31
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    @Victor123 if you are the majority of the volume and open interest, then you are a large market participant. If the spreads are freaking huge, then it is less liquid. – CQM Mar 13 '15 at 17:33
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One thing you can do is use your knowledge of synthetic options to reduce your brokerage trading fee's.

Why pay $20 for a long 100 + short call, when you can simply buy a put and save $10 at Ebaby. For a small time trader, this can add up quick.

Alternatively (and sometimes more costly), if in a mid-swing option play, you wouldn't have access to pre-market/after hours trading. But if you understand the relations between synthetic to actual holdings, one can frequently lock a price they like with physical shares during ext hours by doing the opposite of whichever synthetic you're holding. Won't save anything on trading fee's, but you never know when an after hours sell-off will revert back or stay real the next morning. Or just sometimes the bid/ask on thinly traded options is just too wide and it makes financial sense to close your synthetic with physical shares.

  • Thanks. When you say 'close the synthetic with physical shares', you mean doing a conversion/reversal, correct? – Victor123 Mar 17 '15 at 13:51
  • yeah, exactly. But then again, that only works for certain synthetics. Sometimes buying shares doesn't close the synthetic but converts it into a different synthetic. – Knuckle-Dragger Mar 17 '15 at 16:28

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