What is a 'Synthetic Forward Contract'

A synthetic forward contract, or synthetic long forward contract, is a position in which the investor buys a call option and sells a put option at the same time. Both options must have the same strike price and expiration date

Its purpose is to mimic a regular forward contract, and is also called a synthetic futures contract. The investor will typically pay a net option premium when executing a synthetic forward contract as not all the premium paid for the long position is offset by sale of the short position.

For a synthetic short forward contract, the investor buys a put and sells a call, again with the same strike price and expiration date.

BREAKING DOWN 'Synthetic Forward Contract'

Synthetic forward contracts can help investors reduce their risk, although as with trading futures outright, investors still face the possibility of significant losses if they don't implement proper risk management strategies. A major advantage of synthetic forwards is that a "forward" position can be maintained without the same types of requirements for counterparties, including the risk that one of the parties will renege on the agreement.

How the Trade Works

For example, to create a synthetic long forward contract on a stock, buy a call with a $60 strike price. And at the same time, sell a put with a $60 strike price and same expiration date. At expiration, the investor will buy the underlying asset by paying the strike price.

If the stock price is above the strike price on the expiration date, the investor, who owns the call, will want to exercise that option and pay the strike price to buy the stock.

If the stock price at expiration is below the strike price, the owner of the put that was sold will want to exercise that option. The result is the investor will also buy the stock by paying the strike price.

In either case, the investor ends up buying the stock at the strike price, which was locked in when the synthetic forward contract was established.

Keep in mind that there could be a cost for this guarantee. It all depends on the strike price and expiration date chosen. Put and call options with the same strike and expiration may be priced differently, depending on how far in or out of the money the strike prices may be. Typically, the parameters chosen end up with the call premium being slightly higher than the put premium, creating a net debit in the account at the start.

  1. Reverse Conversion

    A finance and risk management technique based on a put-call parity ...
  2. Synthetic ETF

    A synthetic ETF (exchange-traded fund) mimics the behavior of ...
  3. Strike Price

    The price at which a specific derivative contract can be exercised. ...
  4. Synthetic Biology

    Synthetic biology is the engineering of biomatter DNA to form ...
  5. Roll Forward

    To extend the expiration or maturity of an option or futures ...
  6. Expiration Date (Derivatives)

    The last day that an options or futures contract is valid. When ...
Related Articles
  1. Trading

    Synthetic Options Provide Real Advantages

    Participate in options trading trading that is simpler, less expensive and easier to manage.
  2. Trading

    Options Strategies for Your Portfolio to Make Money Regularly

    Discover the option-writing strategies that can deliver consistent income, including the use of put options instead of limit orders, and maximizing premiums.
  3. Investing

    Synthetic vs Physical ETFs

    New and advanced versions of ETFs have been developed over the years.
  4. Trading

    Three Ways to Profit Using Put Options

    A brief overview of how to profit from using put options in your portfolio.
  5. Trading

    Three Ways to Profit Using Call Options

    A brief overview of how to provide from using call options in your portfolio.
  6. Trading

    Stock Futures vs. Stock Options

    A quick overview of how stock futures and stock options work and why you would pick one over the other depending on the strategy being used.
  7. Personal Finance

    Tips for Answering Series 7 Options Questions

    We'll show you how to ace the largest and most difficult section of this exam.
  1. How do I set a strike price for an option?

    Learn about the strike price of an option and how to set a strike price for call and put options depending on risk tolerance ... Read Answer >>
  2. What does it mean to roll a derivative contract?

    Find out more about derivative securities, how to roll forward a derivative contract and what it means when a derivative ... Read Answer >>
  3. How do I change my strike price once the trade has been placed already?

    Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >>
  4. What is the difference between in the money and out of the money?

    Learn about how the difference between in the money and out of the money options is determined by the relationship between ... Read Answer >>
  5. How does a forward contract differ from a call option? (AAPL)

    Find out more about forward contracts, call options, the mechanics of these financial instruments and the difference between ... Read Answer >>
Hot Definitions
  1. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  2. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  3. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  4. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
  5. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
  6. Monte Carlo Simulation

    Monte Carlo simulations are used to model the probability of different outcomes in a process that cannot easily be predicted ...
Trading Center