Synthetic positions are financial positions that mimic another position but use different instruments to do so....

Synthetic positions are financial positions that mimic another position but use different instruments to do so. A short sale of a stock is a strategy where we borrow shares under the expectation that their prices will drop. If they do, then we buy them back and repay the loan at a profit. In doing so, we are financially obligated for the whole value of the shares which could cost us a large amount of money. A synthetic short sale mimics the short with options but without the large financial cost.

A synthetic short sale is created with a long put and a short call with the same strike price and expiration dates. Bank of America stock is currently trading at $21.71 per share. A May $25 call is trading at $2.75 and a May $25 put is currently trading at $2.25.

Evaluate the payoffs of a short sale of BOA and the synthetic short sale at prices of $18, $25 and $28. Don’t forget the premiums on the options in your calculations and that each contract is for 100 shares. Assume your short sale is 100 shares also.
Draw a payoff profile for each strategy.
Compare the payoffs of each strategy in terms of monetary outlay and payoff at each price.

Expert Solution

Note: Number of shares in call and put option contract is 100 shares

Profit/(Loss) at various stock prices using both methods. Actual short selling and synthetic short selling using options

jeff jeffy answered 2 years ago

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