Synthetic Put

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DEFINITION of 'Synthetic Put'

A trading strategy that combines the short sale of a security with a long-call position on the same security. Synthetic put combination is to effectively create a synthetic put position that has almost the same risk-reward attributes as a straightforward put position, but with added advantages such as flexibility and liquidity. Synthetic puts are often used by institutional investors to disguise their trading bias (bullish or bearish) on a specific security.

BREAKING DOWN 'Synthetic Put'

For example, a synthetic put on Widget Maker Inc. that is trading at $20 would consist of a short sale on the stock, and the simultaneous purchase of short-term calls on the stock with a strike price of $20. This combination trade is equivalent to buying a put on Widget Maker Inc. with a strike price of $20. If the stock price declines to $10 by the time the calls expire, the net profit on the synthetic put position would be $10 - i.e. the short sale position would have a profit of $10, while the calls will expire worthless. If a straight put with a strike price of $20 had been purchased instead, the profit on it would also be $10.

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