If you are a professional future trader in the markets then transaction cost plays a major role while trading. Lower the transaction cost translates to better returns and also reduces the risk to greater extent in the long run. By constructing a Synthetic Futures (Long/Short) we can reduce the total transaction cost by two-third of the actual instead of trading the futures.
Synthetic Longs/Short future is nothing but artificially replicate a long/short futures pay off using same expiry options. Synthetic Long Futures is constructed by using Buying 1 At the money call and Selling 1 At the money put of same strike price . Similarly Synthetic Short Futures is constructed by using Buying 1 At the money put and Selling 1 At the money call of same strike price
Synthetic Long Futures = Buy 1 ATM Call + Sell 1 ATM Put
Synthetic Short Futures = Buy 1 ATM Put + Sell 1 ATM Call
Lets Assume that Mr Ravi is a professional trader on an average he trades 10 lots of nifty futures in a day and he trades with a discount broking firm at Rs20/Order. If Nifty is trading at 8100 then his average transaction cost (including Brokerage + Govt Charges) comes around Rs957/- per buy and sell transaction. Total Transaction Cost is shown below.
Now lets construct a Synthetic Long Futures using 8200CE ATM Call Longs and Shorting 8200PE ATM Put Short (November Series) as shown below
Payoff Graph for Synthetic Long Futures is shown below.
In case of Synthetic Futures both the leg transaction cost come down to Rs 315/-. Ravi would have saved Rs642/ instead of trading futures which directly translates to two-third of brokerage savings. In a year if you assume there are 250 trading sessions then probably he would save 642 x 250 = Rs1,60,500/- annually (approx figures) which makes a huge difference in his trading system returns and thereby improved ROI.
Note : Synthetic Future is recommended to be used only for Nifty/Bank Nifty Trading because of high liquidity and lower impact cost