Home > Strategies Summary > Strategy 5 Synthetic Put-Call

Strategy 5

"Synthetic Put" Financed by Selling a Call Option

Implemented (hypothetically) on March 15, 2005

West Texas Example:
This information is displayed as an example for educational purposes only.

NYBOT No. 2 Futures Contract :	Dec. 05
Futures Price (03/15/05 settlement; cents/lb)	58.000
Strike Price for Purchased Put Options (cents/lb)
Premium for Purchased Put Options (cents/lb)
Strike Price for Sold Put Options (cents/lb)
Premium for Sold Put Options (cents/lb)
Strike Price for Purchased Call Options (cents/lb)	59.000
Premium for Purchased Call Options (cents/lb)	4.540
Strike Price for Sold Call Options (cents/lb)	65.000
Premium for Sold Call Options (cents/lb)	2.500
Assumed Commissions (cents/lb)	0.0008
Assumed Local Basis (cents/lb)	7.000
Assumed** Harvest-Period Differential Between Futures & Adj. World Price (cents/lb)	8.000

Futures:	Local Cash Price (1)	Net Paid Premiums (2)	>Put Option Mkt. Value (3)	Call Option	Example LDP (4)	Total Net Price
44	37.00	2.040	14.00	0.00	16.00	64.96
45	38.00	2.040	13.00	0.00	15.00	63.96
46	39.00	2.040	12.00	0.00	14.00	62.96
47	40.00	2.040	11.00	0.00	13.00	61.96
48	41.00	2.040	10.00	0.00	12.00	60.96
49	42.00	2.040	9.00	0.00	11.00	59.96
50	43.00	2.040	8.00	0.00	10.00	58.96
51	44.00	2.040	7.00	0.00	9.00	57.96
52	45.00	2.040	6.00	0.00	8.00	56.96
53	46.00	2.040	5.00	0.00	7.00	55.96
54	47.00	2.040	4.00	0.00	6.00	54.96
55	48.00	2.040	3.00	0.00	5.00	53.96
56	49.00	2.040	2.00	0.00	4.00	52.96
57	50.00	2.040	1.00	0.00	3.00	51.96
58	51.00	2.040	0.00	0.00	2.00	50.96
59	52.00	2.040	-1.00	0.00	1.00	49.96
60	53.00	2.040	-2.00	1.00	0.00	49.96
61	54.00	2.040	-3.00	2.00	0.00	50.96
62	55.00	2.040	-4.00	3.00	0.00	51.96
63	56.00	2.040	-5.00	4.00	0.00	52.96
64	57.00	2.040	-6.00	5.00	0.00	53.96
65	58.00	2.040	-7.00	6.00	0.00	54.96
66	59.00	2.040	-8.00	6.00	0.00	54.96
67	60.00	2.040	-9.00	6.00	0.00	54.96
68	61.00	2.040	-10.00	6.00	0.00	54.96
69	62.00	2.040	-11.00	6.00	0.00	54.96

Discussion

This strategy adds the sale of an out-of-the-money call option to finance a synthetic put.

Implementing this strategy requires setting up a margin account in order to sell futures. But, if prices rise, the increasing call option value will eliminate the need to post additional margin money.

It retains the advantage of options in setting a price floor (at sold futures price less the call option premium, less the basis) while allowing for you to take advantage of higher cash prices

The LDP works on top of the put option in providing increasing (offsetting) income as prices fall below the low 50s.

The pink colored cells to the left show instances where the vlue of the short futures positions becomes negative. Similarly, the combined value of the call options levels off above 60 cents.

Notes:

Local price is assumed to differ from futures by a constant basis. In reality, this differential is subject to possible "Basis risk" variations.
Premiums paid (less received) for bought (or sold) options.
These values are net of commissions. These values assume only intrinsic value for purchased options, which is realistic when the option is close to expiration, or when exercising into a futures position.
For illustrative purposes only, future LDP value is represented as a fixed 14-cents below the A-Index, which is assumed to be a fixed 7-cents above futures.In reality, the A-index can vary widely in relation to futures,and also vary to a lesser amount from the AWP.

The negative numbers in the value of future position column illustrates the risks of selling options. It exposes you to the risk of assuming a short futures position in a rising market.

The Cotton Marketing Planner
http://agecon2.tamu.edu/people/faculty/robinson-john/

Dr. John R. C. Robinson
Associate Professor
Extension Economist-Cotton Marketing
Department of Agricultural Economics
Texas A&M University
2124 TAMU
College Station, TX 77843-2124
Phone: (979) 845-8011
Fax: (979) 845-4906
Email: jrcr@tamu.edu