Valuing Synthetic Options and Understanding Their Risk Profiles

Summary

The document answers a question about research on synthetic options, including their valuation and time decay. It distinguishes simple synthetic positions, such as a synthetic long stock, from more elaborate synthetic structures designed to replicate complex options strategies. A simple synthetic position can provide a leveraged version of an underlying position’s risk profile, so analyzing it largely repeats analysis of that underlying exposure. The response points to a paper on synthetic options for asset allocation as an example of literature on more advanced replication strategies.

For valuation, it gives a straightforward principle: add the values of the instruments that make up the synthetic position. This helps explain why a synthetic position does not necessarily require a separate valuation framework. The response does not develop a method for calculating time decay, provide empirical evidence, or discuss assumptions such as transaction costs, financing, dividends, and differences in contract terms. Its guidance is therefore introductory; more complex constructions and practical implementation require further study.

Key ideas

• A simple synthetic long position can reproduce the underlying asset’s risk profile with leverage.
• Analyzing a basic synthetic position may largely duplicate analysis of the underlying exposure.
• More advanced synthetic positions can be used to replicate complex options structures.
• The value of a synthetic position is the sum of the values of its component instruments.
• The response does not explain how to calculate time decay or account for implementation costs.

Tags

# Papers on synthetic options


# Papers on synthetic options












I'm looking for some scientific papers to get a better grasp of synthetic options mainly the valuation, eventual time decay etc.. I've looked in my university library and only but I only found obscure references.

kind regards

## Answer by AdB (score 1, accepted)

https://quant.stackexchange.com/a/44921

As mentioned in the comments, you will most likely not find much literature on simple synthetic positions such as the synthetic long stock. This is simply a way to obtain a highly leveraged version of the same risk profile as a long stock position - hence, analyzing the risk profile is redundant. However, there are a few papers on taking more advanced synthetic positions to replicate complicated options structures. See for example:

Tilley, James A., and Gary D. Latainer. "A Synthetic Option Framework for Asset Allocation." Financial Analysts Journal 41, no. 3 (1985): 32-43. http://www.jstor.org/stable/4478840.

Valuation is is in general completely trivial, since the value of a synthetic position is simply the sum of the values of its components.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.