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The synthetic long stock split-strike option strategy is a strategy that aims to replicate the performance of owning the underlying stock.
It involves combining two options with different strike prices but the same expiration date. The strategy is sometimes referred to as a risk reversal which is the term we will use in this article.
To create a risk reversal, an investor would sell an out-of-the-money put option and simultaneously buy an out-of-the-money call option.
By pairing these options, the investor can closely replicate the risk and reward profile of owning the stock.
If the stock price rises, the call option appreciates in value and the put option loses value. A win on both fronts for the trader.
But, if the stock price falls, the call loses value and the short put option rises in value. A double loss for the trader.
One advantage of the synthetic long stock split-strike strategy is that it requires less capital compared to directly buying the underlying stock.
It allows traders to gain exposure to the stock's price movements while reducing the upfront investment.
The risk reversal can be placed for a debit or a credit, but it is best entered for a credit. This way, if the stock stays above the put strike but below the call strike, the trader will still achieve a small return.
AAPL STOCK RISK REVERSAL
Let’s look at an example using Apple (AAPL).
Going out to December expiration, traders could sell the 170 strike put for around $5.40 and buy the 210 strike call for around $3.00.
This would result in a net credit of $2.40 per contract or $240.
Looking at the payoff graph below, we can see that if AAPL is trading between 170 and 210, the trade achieves a profit of $240.
There is significant upside potential above a price of 210, but also large downside below a price of 170.
It’s important to remember that there is significant loss potential with the trade. In fact, the potential loss is similar to owning 100 shares of AAPL stock.
AAPL COMPANY DETAILS
The Barchart Technical Opinion rating is a 100% Buy with a Strengthening short term outlook on maintaining the current direction.
Long term indicators fully support a continuation of the trend.
Apple stock is rated a Strong Buy according to 17 analysts with 3 Moderate Buy and 7 Hold ratings.
Apple's business primarily runs around its flagship iPhone.
However, the Services portfolio that includes cloud services, App store, Apple Music, AppleCare, Apple Pay & licensing and other services which become the cash cow.
Moreover, non-iPhone devices like Apple Watch and AirPod have gained significant traction.
In fact, Apple dominates the Wearables and Hearables markets due to the growing adoption of Watch and AirPods.
Solid uptake of Apple Watch also helps Apple to strengthen its presence in the personal health monitoring space. Apple also designs, manufactures and sells iPad, MacBookand HomePod.
These devices are powered by software applications including iOS, macOS, watchOS and tvOS operating systems.
Apple's other services include subscription-based Apple News, Apple Card, Apple Arcade, new Apple TV app, Apple TV channels and Apple TV, a new subscription service.
SUMMARY
Overall, the synthetic long stock split-strike strategy provides traders with an alternative way to participate in the stock market's movements while reducing the initial capital required.
As with any trading strategy, it is crucial to thoroughly understand the risks involved and perform proper analysis before implementing it.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
