What is a Synthetic Put Strategy?

In the world of options trading strategies, a synthetic put strategy offers an intelligent way for investors to manage risk. This approach mimics the payoff of a long put option using a short position in the underlying asset and a long call option.

In simple terms, the synthetic put strategy helps protect against rising prices when you are already holding a short position. Let’s break this down into easy-to-understand sections to see how this strategy works, its benefits, and when you should consider using it.

Understanding the Synthetic Put Strategy

A synthetic put strategy involves combining two components:

1. Shorting the stock (or selling a futures contract in India)
2. Buying a call option at the same or similar strike price

This combination creates a synthetic put option — a position that behaves just like holding a long put. It allows traders to benefit from a price drop while limiting potential losses if the stock or index suddenly rises.

In the Indian markets, since short-selling is not allowed for more than one day in the cash market, traders typically use futures contracts along with options to create this strategy.

How Does a Synthetic Put Strategy Work?

Think of the synthetic put strategy as a safety net for when you’re betting that a stock or index will fall. Here’s how it works in simple terms: You start by selling the stock (or a futures contract) because you believe its price will go down. If the price does fall, you make a profit from this short position.

But markets are unpredictable. What if the price unexpectedly goes up? That’s where the second part of the strategy comes in — you buy a call option. This option gives you the right to buy the stock at a fixed price, which means if the stock price rises too much, your losses from the short position are limited because the call option will start gaining value.

When to Use a Synthetic Put Strategy?

Knowing when to use synthetic put strategy is key to making it effective. Here are some situations where this strategy makes sense:

• Ahead of earnings or event-based volatility
• When you’re bearish on the stock but want downside protection
• If you want to maintain flexibility while limiting risk
• When hedging short futures positions during uncertain market trends

Real-Life Example

Let’s assume you expect a stock like ABC Ltd. to fall in the short term. Here’s how you can create a synthetic put:

• Current Spot Price: ₹2,500
• 1-Month Futures Price: ₹2,520
• Lot Size: 500 shares
• Call Option Strike Price: ₹2,520
• Call Option Premium: ₹70 per share

Step 1: Short 1 futures contract = Short 500 shares at ₹2,520 Step 2: Buy 5 call option contracts = 5 × 100 = 500 shares at ₹70/share Total Premium Paid: ₹70 × 500 = ₹35,000

Now, let’s examine possible outcomes at expiry:

Scenario A – Price Rises to ₹2,700

• Futures Loss = ₹90,000
• Call Option Gain = ₹55,000
• Net Loss = ₹35,000

Scenario B – Price Drops to ₹2,300

• Futures Profit = ₹1,10,000
• Call Option expires worthless = Loss ₹35,000
• Net Profit = ₹75,000

Scenario C – Price Stays at ₹2,520

• No gain or loss on futures
• Call Option expires worthless
• Net Loss = ₹35,000 (premium cost)

This example clearly illustrates how a synthetic put strategy helps limit losses and mimic the benefits of a long put option.

Synthetic Put Strategy Benefits

• Capital Protection:It provides insurance against sudden upward movement in prices.
• Cost-Efficiency:Setting up a synthetic put can be cheaper than directly buying a long put in some cases.
• Flexibility:You don’t need to close your short position if the trend continues; you can let the call expire.
• Lower Transaction Load:This strategy reduces the need for constant buying/selling adjustments.

Things to Keep in Mind

• Option Premium:The cost of buying the call option affects your break-even point.
• Brokerage and Margin Requirements:Futures contracts need margins, and option buying involves premiums.
• Limited Profit Potential:While losses are limited, so are gains if the asset falls too fast and you want to close early.
• Market Direction Must Be Clear:This is a bearish strategy with an insurance component. Use it only when you’re sure of a downtrend.

Synthetic Put vs Long Put

In simple terms, a long put is easier and cheaper to set up, ideal for beginners. A synthetic put offers more flexibility but involves more capital and is better suited for experienced traders who also use futures.

Is Synthetic Put Strategy for You?

If you’re a trader looking to hedge a bearish view while keeping risk under control, a synthetic put option might suit you. It’s especially useful for advanced options traders or those familiar with futures trading.

However, beginners should first understand how both call options and futures work before combining them. This strategy works well in uncertain conditions where the downside is expected, but a sudden upside surprise cannot be ruled out.

Conclusion

The synthetic put strategy offers a smart solution to protect short positions in a volatile market. It mirrors the risk and reward of a long put option, giving you peace of mind that losses won’t spiral out of control. At the same time, it allows you to benefit if the market moves in the expected direction.

Like all options trading strategies, this too comes with trade-offs. The call premium is a sunk cost, and the need to manage futures positions carefully is critical. But for traders, especially those active in F&O markets, learning when and how to use synthetic put strategy can be a valuable tool in risk management.

By combining a short futures position with a protective call option, you set up a balanced position that’s well-suited for uncertain market moves — just like taking out an insurance policy for your investment view.

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