A synthetic short stock position uses options to replicate the profit and loss profile of shorting 100 shares of stock. By combining a long put and a short call at the same strike price, you create a position that profits when the stock declines - without actually borrowing and selling shares.
What is Synthetic Short Stock?
Synthetic short stock is an options strategy that mimics having a short position in the underlying stock. The position consists of buying a put option and selling a call option at the same strike price and expiration date. The result is a position that profits dollar-for-dollar when the stock falls and loses dollar-for-dollar when it rises.
Simple version: Instead of borrowing shares to sell short, you buy a put and sell a call at the same strike. Your profit and loss will exactly match what you would have made or lost from shorting 100 shares.
How to Create Synthetic Short Stock
The construction is the mirror image of synthetic long stock:
- Buy 1 put option at strike price X
- Sell 1 call option at strike price X
- Both options have the same expiration date
Synthetic Short Stock Example
Stock XYZ is trading at $100. You believe it will decline but cannot or do not want to short the actual shares.
- Buy 1 $100 put for $5.00 ($500)
- Sell 1 $100 call for $5.00 ($500 credit)
Net cost: $0 (or very small debit/credit depending on pricing)
If stock drops to $80: Put worth $20, call expires worthless = +$2,000 profit
If stock rises to $120: Put expires worthless, call costs $20 = -$2,000 loss
This matches exactly what shorting 100 shares at $100 would produce.
Why Use Synthetic Short Instead of Actual Short?
1. No Borrowing Required
Shorting stock requires borrowing shares from your broker. Some stocks are hard to borrow or have high borrowing costs. Synthetic shorts do not require borrowing.
2. No Short Squeeze Risk
When you short actual shares, your broker can force you to close if shares become hard to borrow. Synthetic positions cannot be called back.
3. No Uptick Rule Restrictions
Some markets have uptick rules that prevent shorting on downticks. Options are not subject to these rules.
4. Potentially Lower Costs
Hard-to-borrow stocks can have significant borrowing fees. Synthetic shorts avoid these costs (though this is often priced into the options).
5. Leverage
Like synthetic longs, synthetic shorts require less capital than the full short position value.
Risks of Synthetic Short Stock
1. Unlimited Upside Risk
Just like shorting actual stock, synthetic short has theoretically unlimited loss potential if the stock rises significantly.
2. Assignment Risk
The short call can be assigned early, forcing you to sell shares at the strike price. If you do not own shares, this creates a short stock position.
3. Margin Requirements
The short call creates margin obligations. If the stock rises, you may face margin calls.
4. Dividend Risk
If assigned on the short call, you may be responsible for paying dividends on the short stock position created.
5. Expiration Management
Positions expire, requiring active management to maintain the short exposure.
Warning: Synthetic short stock has unlimited risk if the stock rises. Unlike buying puts alone (which has defined maximum loss), the short call exposes you to unlimited losses. Always size positions appropriately and use risk management.
Choosing Strike Prices
At-the-Money (ATM) Strike
- Zero or near-zero cost entry
- Delta of approximately -100 (matches short stock perfectly)
- Most common choice for pure short exposure
In-the-Money (ITM) Put / Out-of-the-Money (OTM) Call Strike
- Creates a debit (you pay to enter)
- Effectively shorting stock at a higher price
- More bearish view required
Out-of-the-Money (OTM) Put / In-the-Money (ITM) Call Strike
- Creates a credit (you receive money to enter)
- Effectively shorting stock at a lower price
- Less bearish but receive premium upfront
Strike Selection Example
Stock at $100:
ATM synthetic short: Buy $100 put, sell $100 call = approximately $0
Aggressive bearish: Buy $105 put for $7, sell $105 call for $2 = $5 debit (like shorting at $105)
Conservative bearish: Buy $95 put for $2, sell $95 call for $7 = $5 credit (like shorting at $95)
Synthetic Short vs Buying Puts
| Factor | Synthetic Short | Long Put Only |
|---|---|---|
| Maximum Loss | Unlimited | Premium paid |
| Cost | Zero or near-zero | Debit required |
| Time Decay | Neutral (short call offsets long put) | Works against you |
| Delta Exposure | -100 (full short exposure) | -30 to -80 (partial exposure) |
| Profit Potential | Full downside (stock to $0) | Full downside minus premium |
Synthetic Short vs Actual Short Selling
| Factor | Synthetic Short | Short Selling Stock |
|---|---|---|
| Borrowing Required | No | Yes |
| Borrow Fees | None | Can be significant |
| Recall Risk | None | Yes |
| Dividends | Not directly responsible | Must pay dividends |
| Expiration | Yes (must manage) | No (hold indefinitely) |
| Assignment Risk | Yes (on short call) | No |
When to Use Synthetic Short Stock
- Hard-to-borrow stocks: When shorting is expensive or unavailable
- Avoiding borrow fees: On stocks with high short interest and borrowing costs
- Bearish view with zero cost: When you want short exposure without upfront premium
- Hedging long stock: Convert existing long shares to neutral by adding synthetic short
- Time-limited short thesis: When you only need short exposure for a specific period
Managing Synthetic Short Positions
- Set stop losses: Define your maximum acceptable loss before entering
- Monitor for assignment: Watch the short call, especially around ex-dividend dates
- Roll before expiration: If you want to maintain the position, roll to later expiration
- Have a profit target: Decide when you will take profits and exit
- Watch margin requirements: Keep sufficient capital for potential margin calls
Combining with Stock Positions
Synthetic short can be used with existing stock positions:
- Long stock + synthetic short = neutral: Offsets your stock position
- Short stock + synthetic long = neutral: Offsets your short position
- Converting positions: Use synthetics to change your directional exposure without trading stock
Track Your Synthetic Positions
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Summary
Synthetic short stock replicates a short position using options - buy a put and sell a call at the same strike. This strategy is useful when you want to avoid borrowing shares, bypass short-sale restrictions, or need short exposure without high borrow fees. Remember that synthetic shorts have unlimited risk on the upside, just like actual short selling. Always use proper position sizing and risk management when trading this strategy.
Learn about related strategies: synthetic long stock and conversion and reversal.