You have been asked to create a synthetic short position in a forward contract that permits you to sell 10 units of the underlying one year from now at a price of $50 per unit. (1) Describe the positions you need to take in call and put options to achieve the synthetic short forward position. (2) If the underlying is selling for $48 today (i.e. So = 48), what is the cost of your synthetic short position?

Solution :

with the same exercise price.

X = exercise price = 50

1). Position to be taken :

-- buy 10 numbers of Put options with strike price of $ 50 per unit.

--- short (sell) 10 numbers of Call option with strike price of $ 50 per unit.

2). Cost of synthetic short position = ,

where, P = price of 1 put ption

           C = price of 1 call option

The Call - Put parity equation :

Here, C = Call premium

          X = strike price of call and Put

          r = annual rate of interest

           t = time in years

          = initial price of underlying

          P = Put premium

Therefore,

Here, t = 1, = 48, X = 50

So the cost of the position is given as :

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