This segment focuses on establishing a synthetic short position in a stock using options, including when this is desirable, how dividends impact pricing and why the pricing can sometimes be well away from the market. There is no study here, just some good solid knowledge that may give you some trading ideas.
A trader shorting a stock borrows the shares from a brokerage firm, sells the stock and then, hopefully for the trader, buys them back at a cheaper price. An alternative is to use options to create a synthetic short. Usually this consists of a long ATM put and a short ATM call. Barring a dividend or a hard-to-borrow stock (which will be addressed below) the cost basis is usually slightly worse to account for costs such as interest.
A stock is “hard-to-borrow.” when too many people want to short the stock. Most firms have lists of easily borrowable stocks and hard-to-borrow stocks. Sometimes a firm cannot find a borrow or the cost to borrow the stock are too high. That is why some use a synthetic position. An example of a synthetic short using LNKD was displayed.
There are times when the cost basis of the short synthetic will be lower than the price of the stock. That is either because there is a dividend coming or the stock is very hard to borrow. Both possibilities will be priced into the options. That also means if you see a price for a synthetic short and it seems too good to be true it almost always is. Make sure there is no special dividend.
Watch this segment of “Market Measures” with Tom Sosnoff and Tony Battista for the takeaways and other information you should know about synthetic shorts.
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