Synthetic Forward Contract

  

Categories: Derivatives

A forward contract simply refers to a deal that executes some time in the future. You aren't buying 100 shares of NFLX now. You agree to buy 100 shares of NFLX in September, at a price of $400.

A synthetic forward achieves the same goal, except without actually involving a forward contract. Instead, you use a combination of puts and calls to create the same scenario, only in a different way.

You want to recreate that forward to buy 100 shares of NFLX at $400, expiring in September. You buy a call contract (an option to purchase the shares) for 100 shares of NFLX at $400, with a September expiration. Then you write a put, i.e. you sell the option for someone else to sell you 100 shares of NFLX at $400 a share, expiring in September.

So...you're buying a call and selling a put. Both have the same strike price and expiration. (You can create a synthetic short forward contract by selling a call and buying a put.)

If NFLX rises to $420 between now and September, you'll exercise your call (the put will expire unexercised) and buy the shares for $400. If shares of NFLX drop to $380, the party who purchased your put contract will exercise it, forcing you to buy shares of NFLX at $400 a share (the call will expire unused). In either case, you end up buying shares at $400...same as if you purchased the forward contract.

Related or Semi-related Video

Finance: What is a Derivative?23 Views

00:00

finance a la shmoop what is a derivative? well it's derived it's a something taken

00:10

from something else like a derivative of hot weather is thirst a derivative of [Girl takes sip of glass of water on a beach]

00:16

hunger is well you know crankiness that's diva thing you get there...

00:20

derivative of a 1/32 quarterback rating in the NFL is like serious wealth yeah

00:26

yeah discount double shmoop yeah look for it be on there with aaron

00:30

and a derivative of a stock or bond or other security is a something which

00:35

derives its value based on the performance of that underlying security

00:40

there are basically two flavors of derivative put options ie the right to [Ice cream flavors appear]

00:44

sell a security at a given price over a given time period and a call option, ie

00:49

right to buy a security at a given price over a given time period

00:52

well the price of that option is derived from the price of the security and a few

00:59

other factors like strike prices and duration and all that stuff

01:05

colonel electric the downgraded new version of General Electric is trading [Colonel Electric appears in a suit]

01:10

for 25 bucks a share a derivative of its share price is sold in the form of a

01:15

call option with a $30 strike price expiring about 90 days from now on the

01:19

third Friday of the end of that month well investors pay a price albeit

01:24

probably a small one for the right to then pay 30 bucks a share for colonel [Call option appears for colonel electric]

01:29

electric at any time in the next 90 ish days until that option expires making the bet

01:34

that the stock will go well above 30 bucks a share in that time period that

01:39

call option is thus a derivative of the colonel electric primary stock price got

01:45

it if you really want to get personal well here's the ultimate form of

01:49

derivative [Baby laying down]

Up Next

Finance: What Is a Put Option?
83 Views

What is a put option? A put option is a type of contract that lets the investor sell shares of a stock at a certain price and within a window of ti...

Finance: What Is a Call Option?
25 Views

What is a call option? A call option is a type of contract that lets the investor buy shares of a stock at a certain price and within a window of t...

Find other enlightening terms in Shmoop Finance Genius Bar(f)