Synthetic Short Stock (Split Strikes)

Strategy: Sell n OTM Calls, ≤ 56 DTE

Buy n OTM Puts, Same Expiry

Example:

Price Chart: Downtrending

Current IV%: ≥ 40%

IV Rank: ≈ 50

Trade: Sell n OTM call option contracts; buy n OTM put options.

Typical Strike Delta:

OTM Short Calls ≈ −0.45 to −0.40

OTM Long Puts ≈ −0.45 to −0.40

Goals: Like the less aggressive version of the synthetic short stock strategy, traders are bearish and expect the price of the underlying security to experience a price drop. This is evident in this trade’s risk profile. As the price drops, the premium at the strike of the long puts gains value as the long puts move deeper ITM. The premium of the short calls simultaneously loses value as the calls move farther OTM and can be closed for profit by paying substantially less premium than originally received when initially sold.

Manage: When the short stock drops in value by several dollars per share, watch the P/L value. When this trade achieves a satisfactory profit of 30 percent or more, close both the short put and long call options for profit. If the price of the underlying begins to rally contrary to the trader’s bearish bias, the most prudent response is to close the trade. The trader might see how the long puts could be used to leg into a short put butterfly (sell one-half the number of option contracts 1 or 2 strikes above and below). The short calls could be used as the body of a long call butterfly (sell half the number of options 1 or 2 strikes above and below). If the potential return shown by the risk profiles for these two strategies is uncertain, close the entire trade.

Profit: If the trader’s bearish bias is confirmed by a price drop, the trade should be closed when a profit of 30 percent or more is achieved, as both the long puts and short calls are simultaneously returning profits.

Loss: If the trader’s bearish bias is wrong and the price begins to rally, both the short calls and the long puts will begin to lose value. This is especially punishing if a strong upward breakout occurs. So, this trade can potentially suffer a 50 percent or greater loss. Like the synthetic long and short stock strategies, the trader should be confident that a strong price drop will occur before using this synthetic short stock split strikes strategy.