Synthetic Call Strategy

In the Indian derivatives market, traders often look for strategies that offer upside participation with controlled downside risk. While buying a call option is the most common bullish approach, experienced traders sometimes prefer a more flexible alternative known as the synthetic call strategy.

This strategy recreates the payoff of a call option using futures and options. When used correctly, it can offer additional advantages related to dividends, pricing efficiency, and position management, especially in liquid instruments like NIFTY, BANK NIFTY, and large-cap stocks.

This article explains the synthetic call option strategy, with practical examples, risks, and comparisons relevant to the Indian market.

What Is the Synthetic Call Strategy?

A Synthetic Call Strategy is a bullish options strategy designed to replicate the payoff of a long call option without directly purchasing the call. It is commonly used by experienced traders who want upside exposure to a stock or index while maintaining a clearly defined downside limit.

This strategy is particularly relevant in the Indian derivatives market, where margin structures, option pricing, and liquidity conditions can make synthetic positions more efficient than plain vanilla options.

How Is the Synthetic Call Strategy Created?

The strategy is constructed by combining two positions:

• A long futures position (or buying the underlying stock in the cash market)
• A long put option with the same strike price and expiry

The put option offsets the downside risk of the futures position. As a result, losses are capped while the upside remains open. Since the resulting risk-reward profile is identical to that of a call option, the position is formally referred to as a synthetic long call.

How the Synthetic Call Option Strategy Works?

The synthetic call option strategy is based on the mathematical principle of put–call parity. This principle demonstrates that a specific combination of futures (or equity) and options can replicate the exact payoff of a call option.

When a trader combines a long underlying position with a long put option of the same strike price and expiry, the resulting profit-and-loss profile is identical to that of a long call option. This equivalence is what makes the strategy reliable and widely accepted among professional traders.

1. Strategy Setup:

To construct the strategy, two trades are executed simultaneously:

• Buy the Underlying: Purchase the futures contract (or the actual stock in the cash market).
• Buy a Put Option: Buy an at-the-money (ATM) put option with the same expiry as the futures contract.

The put option acts as downside protection, while the futures position provides full upside exposure.

2. Market View:

• Outlook: Moderately to strongly bullish. The trader expects a significant upward move in the underlying asset.
• Risk Preference: Defined and controlled. The trader is willing to pay a known premium (the put option cost) to protect against adverse market movements.

3. Risk and Reward Structure:

This strategy converts the open-ended risk of a futures position into the limited risk profile of an option.

a) Upside Potential

• Unlimited: As the price of the underlying rises, profits increase on a point-for-point basis, adjusted for the put premium paid.

b) Downside Risk

• Strictly limited: No matter how sharply the market falls, losses are capped at a predefined level.

This asymmetric risk structure is the primary reason traders prefer a synthetic call over a naked futures position.

Key Calculations

Understanding these three values is essential before deploying the strategy.

1. Maximum Loss:

Maximum Loss = (Future Entry Price − Put Strike Price) + Put Premium

Important Note: If the Strike is equal to the Entry Price, the loss is just the Premium. If the Strike is lower than the Entry, the difference adds to your loss.

2. Breakeven Point:

Breakeven = Future Entry Price + Put Premium

The underlying must rise by at least the cost of the put option for the position to become profitable.

3. Net Profit at Expiry:

Net Profit = (Market Price at Expiry − Future Entry Price) − Put Premium

Why This Is Safer Than a Naked Futures Position?

Consider a trader buying a NIFTY futures contract at 25,000. (NIFTY lot size: 65).

• Naked Future: Requires ₹2.5 Lakhs margin. A 500-point gap-down results in a loss of ₹32,500 (500 X 65).
• Synthetic Call: By buying a 25,000 Put for 150 points, the margin requirement drops to approx. ₹45,000. The maximum loss is capped at ₹9,750 (150 X 65), providing a massive safety net.

This clearly illustrates how the synthetic call strategy transforms a high-risk futures trade into a controlled, option-like position.

Example of Synthetic Call Strategy

Let’s look at a realistic NIFTY example.

• NIFTY spot: 22,000
• Trader’s view: Bullish for the current expiry

Positions Taken

• Buy NIFTY Futures at 22,000
• Buy 22,000 Put Option at 100 points

Payoff Scenarios

Scenario 1: NIFTY rises to 22,500

• Futures P&L: (22,500 - 22,000) = +500 points
• Put option P&L: The 22,000 Put expires at 0. You lose the 100-point premium.
• Net profit = 500 − 100 = 400 points

Since NIFTY derivatives trade in fixed lot sizes, it is important to translate points into actual rupee terms.

• NIFTY lot size: 65 units
• Total profit: 400 × 65 = ₹26,000

Important note for beginners: The put option is insurance. Its premium is a non-refundable cost, even if the market moves in your favour.

Scenario 2: NIFTY falls to 21,500

• Futures P&L:  (21,500 - 22,000) = −500 points
• Put Option P&L: The 22,000 Put is now worth 500 points (22,000 - 21,500). After subtracting the 100-point premium you paid, your profit on the Put is +400 points
• Net Profit: -500 (Future loss) +400 (Put gain) = -100
• In Rupee Term: -100 X 65 = -6,500

This payoff closely matches that of a long call, adjusted for the premium paid.

Benefits of the Synthetic Call Option Strategy

Let’s understand the benefits of the synthetic call option strategy:

1. Call-Like Payoff with Structural Flexibility:

The synthetic call option strategy offers unlimited upside potential while ensuring that downside risk is capped at a predefined level. Traders can participate in a market rally with greater confidence, knowing that losses are controlled through built-in protection.

This structure combines the profit potential of futures with the risk limitation of options, making it a disciplined alternative to directional futures trading.

2. Dividend Advantage:

One of the most important, but often overlooked, advantages of synthetic calls applies to equity investors.

• Direct Call Option: A call option only provides the right to buy shares. The holder does not receive dividends or other corporate benefits.
• Synthetic Call Using Cash Equity and a Put Option: Since the investor owns the shares in their Demat account, they are entitled to all declared dividends and corporate actions.

Over time, dividend income can partially offset the cost of the put option premium, effectively reducing the net cost of downside protection. This makes synthetic calls particularly attractive for positional and long-term bullish views in Indian stocks.

Note: If you execute this using Cash Equity (buying shares) and a Put option, you receive all dividends. If using Futures, you do not receive dividends directly, though the market usually adjusts the futures price to reflect the dividend yield.

3. Hedged Margin Benefits Under SEBI Regulations:

In the Indian derivatives market, unhedged (naked) futures positions require substantial margin. However, under SEBI’s SPAN margin framework, when a long futures position is protected by a long put option:

• The exchange recognises that downside risk is capped
• Margin requirements are significantly reduced compared to naked futures

This makes the synthetic call strategy more capital-efficient than trading futures without protection.

4. Reduced Exposure to Implied Volatility Risk:

During major events such as Union Budgets, RBI policy announcements, or corporate earnings, call options often trade at elevated implied volatility levels. Buying such calls can result in losses even if the market moves in the expected direction, due to implied volatility contraction (IV crush).

A synthetic call avoids this issue by:

• Taking directional exposure through futures
• Using a put option primarily for protection

In certain market conditions, this structure can be more cost-effective than purchasing high-IV call options.

5. Transparent and Disciplined Risk Management:

The maximum possible loss is defined at the time of trade entry. This clarity helps traders avoid emotional decision-making during short-term market fluctuations. By knowing the worst-case scenario upfront, traders are less likely to exit positions prematurely due to temporary price dips or intraday volatility.

Drawbacks of the Synthetic Call Option Strategy

While the synthetic call option strategy offers strong downside protection and structural flexibility, it also comes with practical and operational challenges that traders must understand before using it.

1. Higher Capital Requirement:

One of the biggest limitations of a synthetic call is the capital required to initiate the position.

• Actual Call Option: The trader only pays the option premium. For example, a NIFTY call option may cost around ₹2,000–₹3,000, depending on market conditions.
• Synthetic Call Strategy: Even after margin benefits from hedging, a NIFTY futures position typically requires roughly ₹45,000 to ₹60,000 in margin, compared to just a few thousand for a naked call.

This higher capital requirement makes the strategy less suitable for small trading accounts.

2. Cost of Protection:

The put option used in the strategy is a wasting asset. Its value decreases over time due to theta (time decay).

If the market remains sideways or moves up slowly, the loss from the declining put premium can reduce or even offset gains from the futures position. This makes timing an important factor in the success of the strategy.

3. Mark-to-Market (MTM) Cash Flow Risk:

This is a critical consideration for traders new to futures-based strategies.

• In a long call option, the maximum possible loss is paid upfront as the premium.
• In a synthetic call, the futures position is settled on a daily mark-to-market basis.

If the market moves against the position, cash may be debited from the trading account to cover daily losses, even if the put option is gaining value. Traders must maintain sufficient free balance to avoid forced position closure.

4. Higher Execution and Transaction Costs:

A synthetic call requires executing two separate trades - buying a futures contract and buying a put option. As a result, traders incur:

• Brokerage on two legs instead of one
• Potential bid–ask slippage while entering and exiting both positions

Over multiple trades, these costs can have a noticeable impact on net returns.

5. Active Monitoring Required:

Unlike a call option, which can often be held until expiry with minimal intervention, a synthetic call requires regular monitoring.

Traders must:

• Track margin utilisation and MTM requirements
• Manage contract expiry and rollover decisions
• Ensure correct quantity matching between futures, equity holdings, and put options

Because of these operational demands, the strategy is better suited for experienced or actively managed trading accounts rather than passive, “set-and-forget” approaches.

Difference Between Synthetic Call and Actual Call Option

Let’s understand the difference between a synthetic call and an actual call option in detail through this table:

Additional Insights to Improve Strategy Usage

Understanding the Greeks:

• Delta: Positive - profits when price rises
• Gamma: Identical to a standard call, providing an option-like explosive move as the stock rallies

This makes the strategy more stable during moderate price moves.

Customisation Tip: Using an out-of-the-money put reduces cost but also lowers protection. This creates a cheaper setup with a lower safety floor, useful for confident bullish views.

Conclusion

The synthetic call strategy is a powerful alternative to buying call options in the Indian market. By combining futures with put options, traders can achieve similar payoffs while gaining flexibility around dividends, volatility, and execution.

However, the strategy is best suited for traders who understand margins, time decay, and position monitoring. For beginners, learning it alongside concepts like protective puts can make the transition smoother.
When used with discipline and clarity, a synthetic long call strategy can be an effective tool for both positional traders and informed investors.