Here is a quote from an investment website about an investment strategy using op

Question

Here is a quote from an investment website about an investment strategy using options:

One strategy investors are applying to the XYZ options is using “synthetic stock.” A synthetic stock is created when an investor simultaneously purchases a call option and sells a put option on the same stock. The end result is that the synthetic stock has the same value, in terms of capital gain potential, as the underlying stock itself. Provided the premiums on the options are the same, they cancel each other out so the transaction fees are a wash. (as cited in McDonald, 2013, question 3.19)

Suppose, to be concrete that the premium on the call you buy is the same as the premium on the put you sell, and both have the same strikes and times to expiration.

a. What can you say about the strike price?

b. What term best describes the position you have created? What is the shape of the profit diagram?

c. Suppose the options have a bid-ask spread. If you are creating a synthetic purchased stock and the net premium is zero inclusive of the bid-ask spread, where will the strike price be relative to the forward price?

d.If you create a synthetic short stock with zero premium inclusive of the bid-ask spread, where will the strike price be relative to the forward price?

e. Do you consider the “transaction fees” to really be “a wash”? Why or why not?

Explanation / Answer

a) Strike Price is a specific derivative where contract can be exercised. For call options, the strike price is where the security can be bought , while for put options the strike price is the price at which shares can be sold in market.Strike prices are one of the key determinants of the premium, which represents the market value of an options contract.nvestors have to choose between maximizing their premium income while minimizing the risk of the stock being “called” away.therefore strike price should be at breakeven so that investor doesnot have loss either on call option or put option.

b)There are two basic types of position: a long and a short.

Since investor cancels of put and call option simultaneously it creates short position for him in my opinion.

e) Transaction fee is a charge for an intermediary, such as a broker-dealer or a bank who assesses for assisting    in the sale or purchase of a security. if call option and put option cacels simultaneously in market at expiration there would not be any charges to be paid off or received.... so it is sett off in other words washed away.

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