You can upgrade your trader status by expanding your leverage with portfolio margin, but first you must know synthetic equivalents—here's a primer.
Want up to 10 times normal margin? Portfolio margin might be your solution. But you have to qualify. Portfolio margin expands your leverage and enhances your trading capabilities. But it carries significant risk. This article, first in a series of four, can help you understand what portfolio margin is and how it works.
Think of synthetics this way: You have a call, a put, and stock. Synthetics take any two of those to make the third. It kinda sounds like a parlor trick. So why is this important enough to have on the portfolio margin test?
You may have a position, like a vertical or calendar, that has a particular risk profile. If one of the options is exercised or assigned—either early or at expiration—the resulting position can be a synthetic with a different risk profile. And knowing the synthetic equivalent position will help you understand the risk.
Before we get to how to quickly determine a synthetic equivalent, let’s first get the lay of the land.
To be clear, the call or put in the actual position and the synthetic equivalent are at the same strike price and at the same expiration. A long 60-strike put has a synthetic equivalent that’s short stock and long the 60-strike call.
With American-style options, if you have a short call vertical that’s short the 70 call and long the 75 call, they can be exercised or assigned before expiration. Let’s also say the stock price is $74, and your short 70 call gets assigned. Overnight, the short 70 call disappears, and in the morning when you look at your account you’ll find you’re short 100 shares and long the 75 call, instead of having that nice short vertical. Yikes! But if you know synthetic equivalents, you can understand the risk of your new position.
Short stock, plus a long 75 call, is equivalent to a long 75 put. If you have enough capital in your account to cover the margin requirement of the short stock, and if it’s not an IRA account (you can’t short stock in an IRA), this position will act like a long put.
In the synthetic equivalent position, the option will be long if the actual option is long, and short if the actual option is short. Likewise, if the synthetic equivalent position is bullish, the actual stock will be long. If the synthetic equivalent position is bearish, the actual stock position will be short.
So what’s the synthetic equivalent of a long call? The call is long, so the synthetic equivalent will contain a long put. A long call is also bullish, so the synthetic equivalent will contain long stock. A long put plus long stock is synthetically equivalent to a long call.
Most likely you’re not going to run into synthetics every day. But they’re handy to know if you have in the money options that might be exercised or assigned. Knowing what they are can help you gain a better-than-average understanding of options.
Consider applying if portfolio margin is right for you. You must meet minimum requirements and have at least $125,000 in total equity.*
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Tom Preston is not a representative of TD Ameritrade, Inc. The material, views and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
Use of portfolio margin involves unique and significant risks, including increased leverage, which increases the amount of potential loss, and shortened and stricter time frames for meeting deficiencies, which increase the risk of involuntary liquidation. Client, account, and position eligibility requirements exist and approval is not guaranteed. Thomas Preston is not a representative of TD Ameritrade, Inc. The material, views and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
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