Alamos Gold rose 5.99% Tuesday after a beautiful bounce off the 50-day moving average. Today, I want to look at using options to create a synthetic long position for a fraction of the cost of buying shares.
A split-strike synthetic trade is a way of taking a position similar to long exposure on a stock without having to put up as much capital. The option premium and margin requirement is usually a fraction of the cost of buying the position outright. We'll get to that shortly.
The strategy is constructed by selling an out-of-the-money put and buying an out-of-the-money call. Let's look at Alamos Gold as an example.
Preparing For Bullish Exposure
Assuming an investor wanted a bullish exposure via a synthetic long, they could sell an 25-strike put and buy an 27-strike call using an Aug. 15 expiration.
This morning, the 25 put traded around 1.30, and the 27 call traded around $2.50. Therefore, an August split-strike synthetic trade cost just 1.20 per contract or $120.
As the name suggests, this is a synthetic position, and the trader has similar exposure to owning 100 shares of the underlying. That exposure would cost about $2,700 if the investor bought 100 shares. So, this is effectively a leveraged position and may not be appropriate for every trader. Certainly, you need to consider a position size that takes into account the leverage.
Even though the option trade only costs $120, the investor could still lose $2,620 if AGI went to $0. Essentially the same risk as owning the stock. But the rewards can be significant, especially in relation to the cost of the trade.
Margin Requirement
This split strike synthetic trade produces a similar exposure to owning 100 shares for a lower cost. In this example the total position delta is around 87 giving the trader an exposure equivalent to being long 87 shares of AGI stock.
The break-even price is 28.20, the cost of the trade at 1.20 plus the call option strike of 27.
For this synthetic long position, the margin requirement would be around $800, so the investor could use the leverage power of options to trade AGI for less.
Of course, leverage is a double-edged sword, and a falling stock price will magnify losses.
Alamos stock, according to the IBD Stock Checkup, is ranked number 2 in its group and has a Composite Rating of 80, an EPS Rating of 83 and a Relative Strength Rating of 47.
Please remember that options are risky, and investors can lose 100% of their investment.
Further, this article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options and is conservative in his style. He believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ
