Synthetic Put

A synthetic put, or synthetic long put, is an options strategy in which an investor, holding a short position in a stock, purchases an at-the-money call option on the same stock. This action is taken to protect against appreciation in the stock's price. A synthetic put is also known as a married call or protective call. 

The synthetic put is a strategy, used when the investor has a bearish bet and is concerned about potential near-term strength in the underlying stock. It is similar to an insurance policy except that the investor wants the price of the underlying stock to fall, not rise. The strategy combines the short sale of a security with a long-call position on the same security.

A synthetic put mitigates the risk that the underlying price will increase. It does not, however, deal with other dangers, which may leave the investor exposed. Because it involves a short position in the underlying stock, it carries with it all the associated risks of an adverse, or up-market, movement. Risks include fees, margin interest, and the possibility of having to pay dividends to the investor from whom the shares were borrowed to sell short. 

Institutional investors can use synthetic puts to disguise their trading bias, be it bullish or bearish, on specific securities. However, for most investors, synthetic puts are best suited for use as an insurance policy. Both a simple short position and a synthetic put have their maximum profit if the stock's value falls to zero. However, any benefit from the synthetic put must be reduced by the price, or premium, which the investor paid for the call option.

The synthetic put strategy can place a practical ceiling, or cap, on the price of the stock for a "fee," the options premium. The cap limits any upside risk for the investor. The risk is limited to the difference between the price of the underlying stock, at the time of the synthetic put purchase, and the option's strike price. Put another way, at the time of the purchase of the option, if the underlying stock traded precisely at the strike price, the loss for the strategy is capped at exactly the amount paid for that option.

Rather than a profit-making strategy, a synthetic put is a capital-preserving strategy. Indeed, the cost of the call portion of the approach becomes a built-in cost. The option's price reduces the profitability of the method, assuming the underlying stock moves the desired direction, lower. Therefore, investors should use a synthetic put as an insurance policy against near-term strength in an otherwise bearish stock, or as a protection against an unforeseen price explosion higher. 

Newer investors may benefit from knowing that their losses in the stock market are limited. This safety net can give them confidence as they learn more about different investing strategies. Of course, any protection will come at a cost, which includes the price of the option, commissions, and possibly other fees.