Which of the following is the same synthetic position as short stock, long call?
a. Short put
b. Long call
c. Short call
d. Long put
The correct answer and explanation is :
The correct answer is:
a. Short put
Explanation:
In options trading, synthetic positions replicate the payoff of another position using different instruments. Understanding how different options and stock positions interact is essential for traders to hedge or speculate effectively.
Step 1: Understanding the Given Position (Short Stock, Long Call)
A short stock position means selling shares you do not own, expecting the price to decrease. A long call gives the right to buy the stock at a predetermined price (strike price), which helps cap potential losses if the stock price rises.
- If the stock price decreases, the short stock position gains, and the call expires worthless.
- If the stock price rises, the short stock position incurs losses, but the long call provides protection by allowing the trader to buy the stock at a fixed price.
This setup behaves like a short put option.
Step 2: Comparing with a Short Put
A short put means selling a put option, obligating the seller to buy the stock at the strike price if the buyer exercises it. The payoff structure of a short put mirrors the combined effect of a short stock and a long call:
- If the stock price stays above the strike price, the put expires worthless, and the premium received is the profit.
- If the stock price drops, the put seller must buy the stock at the strike price, similar to how a short stock incurs a loss when the stock price declines.
Since the risk-reward profile of short stock + long call is identical to a short put, the correct answer is short put (a).