Long Stock versus Synthetic Long Stock

Options give traders options. Suppose you want to buy a stock or ETF, your choices are buy for cash, buy on margin or, using options, enter a synthetic long position. Let's look at a recent example to see what I mean.

For this comparison, I'll randomly pick Planet Fitness stock (PLNT) which is a decent stock and has no dividend. This comparison omits commissions for simplicity.

Source: Yahoo Finance "Historical Prices" "Adj close".

Example 1: 12/28/2018 Buy 100 PLNT at $52.58 for $5,258 Cash
Example 2: 12/28/2018 Buy 100 PLNT on 50% margin. $2,629 Cash + $2629 Margin
Example 3: 12/28/2018 Buy 1 PLNT May 17, 2019 $52.50 Call at $6.15 and Sell 1 PLNT May 17, 2019 $52.50 put at $5.50. $65 Cost + $1575* margin required to short the put = $1640.

Example 1 is a simple buy for cash costing your account $5,258.
Example 2 saves cash by using borrowed funds to buy the stock.
Example 3 is called a synthetic long. It uses options to create the same result as a long position.

Lets see how it works out so far this year. Yesterday, 5/3/2019, PLNT closed at $72.67

Example 1 is up $2009 or +38.21% year-to-date.
Example 2 is also up $2009 but it incurred, for this example, a margin cost of $70.10** for a net profit of $1938.90. This net gain divided by the investment (1938.9/2629) equals a 73.75% return!
Example 3 closed at $2025 ($2035 call - $10 put). This was a return of 123.47%!!

Of course if PLNT were to fall, the results would be very different. Example 1 risks your total investment. Example 2 risks your investment plus interest plus margin calls. Example 3 risks your tiny investment plus the risk of being put the stock, i.e. buying the stock at a very unfavorable price, vastly increasing your investment.

*The margin to sell an at-the-money put is roughly 30% of the strike price. $5250 x .3 = $1575. See your broker for your margin requirement.
**Suppose the annual margin rate is 8%. $2629 x .08 /3 = $70.10 is the cost of the loan for 4 months.

Feel free to post comments.

Disclaimer: Posts are for education only and not investment advice, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors.