A synthetic put in investing imitates the effects of a put option using the underlying asset and a call option. A put option provides the owner with the right, but no requirement, to sell a certain quantity of a specific underlying asset at a set price within a certain timeframe. A call option, on the other hand, gives the owner the right to buy a specific quantity of a specific underlying asset at a set price within a certain timeframe.
A put option has a certain strike price at which the owner could sell the asset. If the price of the underlying asset drops below the strike price, the owner can sell the asset at the put strike price, resulting in a profit that becomes bigger the lower the asset price falls. If the price of the underlying asset climbs above the strike price, the owner can choose not to exercise the put option and retain the asset, resulting in a loss as big as the price he or she pays to buy the put option. The owner of a put option, therefore, expects that the underlying asset will decline in price and hope to benefit from it. A put option limits the owner's possible losses to the price paid to acquire the put option.
To create a synthetic put option, a trader can short or sell the underlying asset and buy a call option. Shorting the underlying asset lets him or her benefit from price declines but exposes him or her to unlimited losses. A call option limits the trader's possible losses because he or she would be able to buy the underlying asset at the strike price of the call option to cover his losses from the shorted asset. This creates a synthetic put with a strike price of the call option's strike price. The owner of a synthetic put benefits when the underlying asset's price declines below the strike price and limits his or her losses to the premium and commissions paid on the call option and underlying asset.
A synthetic put, therefore, has the same profit potential and loss limit as a put option. A synthetic put has the benefit of allowing the trader to customize the put option to suit his or her needs. The trader can also adjust his or her position while holding a synthetic put without letting go of the whole position and buying a whole new position.
