Protective Call (Synthetic Long Put) Option Trading Strategy Explained

Published on Thursday, April 19, 2018 | Modified on Wednesday, June 5, 2019

Protective Call (Synthetic Long Put) Options Strategy

Strategy Level	Beginners
Instruments Traded	Call + Underlying
Number of Positions	2
Market View	Bearish
Risk Profile	Limited
Reward Profile	Unlimited
Breakeven Point	Underlying Price - Call Premium

The Protective Call strategy is a hedging strategy. In this strategy, a trader shorts position in the underlying asset (sell shares or sell futures) and buys an ATM Call Option to cover against the rise in the price of the underlying.

This strategy is opposite of the Synthetic Call strategy. It is used when the trader is bearish on the underlying asset and would like to protect 'rise in the price' of the underlying asset.

The risk is limited in the strategy while the rewards are unlimited.

How to use a Protective Call trading strategy?

The usual Protective Call Strategy looks like as below for State Bank of India (SBI) Shares which are currently traded at Rs 275 (SBI Spot Price):

Suppose SBI shares are trading at Rs 275. You are of the view that the price will go down in near future and hence sell 100 shares. Now to protect yourself against a rise in the price and the resultant losses from it, you buy an ATM Call Option of SBI. If the price increases, your loss will be the difference between the strike price of call and strike price plus premium paid. If the prices fall, you will earn profits from the trade in underlying.

The Protective Call Strategy looks like as below for NIFTY which are currently traded at Rs 10400 (NIFTY Spot Price):

Suppose NIFTY is trading at 10400. If we are expecting the price of NIFTY to go down in near future, we sell 1 lot of NIFTY future. Now to protect ourselves against the rise in the price, we buy an ATM Call Option of NIFTY. If NIFTY goes up, our loss will be the difference between the strike price of call and strike price plus premium paid. If the NIFTY goes down, we will earn profits from the futures as we shorted it.

When to use Protective Call (Synthetic Long Put) strategy?

The Protective Call option strategy is used when you are bearish in market view and want to short shares to benefit from it. The strategy minimizes your risk in the event of prime movements going against your expectations.

Example

Example 1 - Stock Options:

Let's take a simple example of a stock trading at Rs 50 (spot price) in June. The option contracts for this stock are available at the premium of:

• July 50 Put - Rs 2

Lot size: 100 shares in 1 lot

1. Sell 100 Shares: 100*50 = Rs 5000 Received
2. Buy 'July 50 Call': 100*2 = Rs 200

Now let's discuss the possible scenarios:

Scenario 1: Stock price remains unchanged at Rs 50

• Sell 100 Shares - No profit/loss except brokerage/taxes paid
• July 50 Call - Expires worthless
• Net Credit was Rs 4800 initially received to take the position.
• Total Loss = Rs 200 which was paid as premium for Call position.

The total loss of Rs 200 is also the maximum loss in this strategy. This is the amount you paid a premium at the time you enter in the trade.

Scenario 2: Stock price goes to Rs 70

• Sell 100 Shares: (50*100) - (70*100) = -Rs 2000
• July 50 Call Expires in-the-money with an intrinsic value of (70-50)*100 = Rs 2000
• Total Loss = - 2000 + 2000 - 200 (Premium Paid) = -Rs 200

In this scenario, Rs 2000 is the loss made from shares shorted. We earned Rs 2000 from the Call options position which nullifies the trade. The net loss made in this transaction is Rs 200 premium paid to take the Call Options position. This is also the maximum loss in this strategy.

Scenario 3: Stock price goes down to Rs 30

• Sell 100 Shares: (50*100) - (30*100) = Rs 2000
• July 50 Call - Expires worthless
• Total Profit = 2000 - 200 (Premium Paid) = Rs 1800

In this scenario, Rs 2000 is the profit earn from shares shorted. We lost the premium paid for call position as it expired worthless. The net profit earned is Rs 1800.

Example 2 - Bank Nifty

Market View - Bearish

When you are bearish on the underlying but want to protect the upside.

Actions

• Sell Underlying Stock or Future
• Buy ATM Call Option

Breakeven Point

Underlying Price - Call Premium

When the price of the underlying is equal to the total of the sale price of the underlying and premium paid.

How to exit?

• Wait for Option to expire.
• Sell the Call Option and book profits.

Simillar Strategies