The Synthetic Long Bullish Combination in Investing - dummies

The Synthetic Long Bullish Combination in Investing

By Paul Mladjenovic

The synthetic long is a great bullish combination. It can offer an unlimited bullish gain potential and no losses. In fact, if you time it well, the synthetic long could also give you a net credit. What’s the catch? Well, you may end up buying a stock you love at a reduced price.

The synthetic long is a simple combination, as you see in the table.

A Basic Synthetic Long
The Legs Potential Gain Potential Loss Comments
Long call Unlimited Lose your premium The premium for the call is paid for by the premium received
from the short put.
Short put Limited to your premium amount Done right, no significant loss, but you may need to buy the
underlying asset
Only do the short put on securities you wouldn’t mind
buying.

This combination is very bullish. It effectively works as if you bought the stock (that’s where the “synthetic” part comes in). It just doesn’t require any capital outlay initially, and you need not own the stock when the trade is implemented.

Suppose you’re bullish on the stock Sky Rocket Up Inc. (SRU), which is currently at $35 per share. The following table gives you the synthetic long combination.

A Sample Synthetic Long
The Legs Strike Price Cost/Price Expiration
Long call $40 Pay $95 Oct. 20, 2017
Short put $30 Receive $100 Oct. 20, 2017
Net credit: $5

As you can see, this combination is a net credit spread of $5 (you receive $100 from the put you wrote, and you paid $95 for the call you bought). It is also a vertical spread because both legs of the combination expire on the same date.

The best time to deploy the (potentially zero-cost) synthetic long is when the stock or ETF you’re eyeing is having a bad day (its price is down sharply), yet the fundamentals and the technicals look good and warrant a bullish outlook. Keep an eye out for bad days, because they could be great entry points for a synthetic long, perhaps even a 2-for-1 combo (one that could thrill you enough to send this author a case of lobster tails).