Synthetic Futures: Overview, Types, Trading & Hedging, Pros vs Cons

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Written by Arjun Remesh | Reviewed by Sunder Subramaniam | Updated on 11 July 2025

Synthetic futures are option-based strategies that replicate the payoff and exposure of traditional futures contracts. Synthetic futures emerged from the need for flexibility in speculative and hedging strategies. 

The 1973 establishment of the Black-Scholes model provided a rigorous mathematical foundation for pricing options, which led to the formalization of put-call parity—the core principle underlying synthetic futures. 

The versatility of synthetic futures extends to hedging, speculation, and even arbitrage. Traders leverage them to optimize margin requirements, manage exposures during contract rollovers, or to exploit temporary mispricings between the options and futures markets. 

A survey of Indian equity derivatives trading in 2023 showed that over 20% of option volumes involved strategies that replicated futures, either for hedging or speculative purposes.

What is a Synthetic Futures?

A synthetic future is a position created by combining options to replicate the payoff of a traditional futures contract. Rather than buying or selling an actual futures contract, traders use a specific combination of options—typically a call and a put with the same strike price and expiration—to mirror the profit and loss exposure of a futures position.

This approach leverages the principle of put-call parity, which states that holding a long call and a short put at the same strike and expiry is financially equivalent to holding a long futures contract. The reverse—short call and long put—mimics a short futures position. By carefully selecting the options’ strike price, traders ensure that the synthetic position closely shadows the price movements of the underlying asset.

How Do Synthetic Futures Work?

Synthetic futures work by using the put-call parity relationship to replicate the payoff of a futures contract through options. The put-call parity principle asserts that owning a long call and a short put on the same underlying, with identical strike prices and expiry dates, results in exposure that is economically equivalent to holding a long futures contract.

To create a synthetic long future, a trader buys a call and sells a put, both at the same strike price and with the same expiry. This combination results in a linear payoff, just like a standard long future: unlimited upside if the underlying asset rises and losses if it falls below the strike. The synthetic short future is constructed by taking the opposite positions—a short call and a long put. This mirrors the payoff profile of shorting a futures contract, profiting if the underlying drops below the strike price.

For these constructions to precisely mirror futures, the options must have the same strike (ideally at-the-money or ATM) and identical expiry. Any mismatch will distort the risk-reward symmetry and lead to tracking errors. 

The net premium paid or received when constructing the synthetic position plays a crucial role in aligning its value with the futures contract. For example, if the combined cost of buying the call and selling the put is positive, the synthetic future’s entry price will be adjusted accordingly.

What are the Types of Synthetic Futures?

There are two main types of synthetic futures: synthetic long futures and synthetic short futures. Each type mirrors the risk and return of either being long or short a standard futures contract but is constructed with options instead of an actual futures trade.

1. Synthetic Long Future

A synthetic long future is made by taking a long call and a short put on the same underlying, strike price, and expiry date. A synthetic long future is bullish and produces the same payoff as buying a futures contract: profits increase as the underlying price rises, and losses occur as it falls. The risk/reward curve is linear, matching the futures contract exactly in both magnitude and direction.

This strategy is particularly useful when direct futures trading is not available, such as in regulatory-restricted environments or on instruments without a liquid futures market. 

For example, an Indian investor wants to get exposure to a specific stock index but cannot access the futures contract. They constructing a synthetic long future with at-the-money options provides an effective workaround. The trader manages the net premium from the call and put, which represents the cost of setting up the synthetic position.

2. Synthetic Short Future

A synthetic short future is created by selling a call and buying a put, both with the same strike and expiry. This combination has a bearish outlook, mirroring the payoff from shorting a future: profits accrue when the underlying price falls, and losses mount as it rises. 

The payoff is again linear, providing identical risk exposure to an outright futures short.

This structure is especially useful when the futures market is illiquid or entirely absent for a given asset. 

Traders who want to take a short view but are unable to access the futures contract directly can use a synthetic short to achieve the same exposure. For instance, if a commodity’s futures market in India is thinly traded, a synthetic short offers a practical alternative for hedging or speculation.

Both types of synthetic futures require careful monitoring of options premiums, margin requirements, and transaction costs to ensure the strategy is effective and cost-efficient.

How Are Synthetic Futures Priced?

Synthetic futures are priced using the put-call parity relationship, which mathematically links options premiums to the forward price of the underlying. 

The core formula for put-call parity is C – P = F – K, where C is the call option premium, P is the put option premium, F is the synthetic future or forward price, and K is the strike price.

This equation ensures that the price difference between a call and a put with the same strike and expiry equals the difference between the future price and the strike price. If the call premium exceeds the put premium by more than the difference between the forward and strike prices, arbitrage opportunities arise.

Traders then construct synthetic positions that lock in risk-free profits until prices realign.

Each element of the formula plays a critical role. The call and put premiums reflect the market’s expectations of future volatility, interest rates, and dividends, while the strike price anchors the calculation. The synthetic future’s value incorporates the implied interest rate over the option’s life, known as the cost of carry. This accounts for financing costs, storage, or other factors affecting the underlying asset between now and expiry.

How to Create and Trade a Synthetic Future?

To create and trade a synthetic future, select at-the-money options with the same strike and expiry, and enter offsetting call and put positions. 

For a synthetic long, buy a call and sell a put; for a synthetic short, sell a call and buy a put. The first step is choosing a strike price at or near the current spot price of the underlying, ensuring the synthetic position tracks the asset’s movements closely.

Next, ensure both options have the same expiration date. This alignment is critical for maintaining the linear payoff profile that matches a futures contract. After selecting the options, calculate the net premium—the difference between the price paid for the call and the price received for the put (or vice versa). This net premium will adjust the synthetic position’s effective entry price.

After entering the trade, monitor the position’s delta, which measures sensitivity to changes in the underlying asset’s price. Adjustments might be required if the options move significantly in or out of the money, or if volatility shifts the value of the options. Managing margin and capital is equally important, since both options positions contribute to the overall exposure.

How to Hedge Synthetic Futures?

Hedging synthetic futures involves constructing offsetting positions that neutralize risk from adverse price movements in the underlying asset. The primary approach uses options themselves or combinations of other derivatives like futures, depending on the trader’s objectives and risk tolerance.

For instance, if you hold a synthetic long future (long call, short put), you hedge by taking a position that gains when the underlying asset falls. This could involve buying a put with a lower strike or selling a call with a higher strike, effectively converting the synthetic future into a range-bound or protected position. The goal is to cap potential losses while allowing for upside within a defined range.

On the other hand, hedging a synthetic short future (short call, long put) would involve buying a call or selling a put at a different strike, limiting downside risk if the underlying asset unexpectedly rallies. This is particularly useful during periods of high volatility or when holding positions into major market events.

Why Use Synthetic Futures in Trading?

Traders use synthetic futures for their capital efficiency, flexibility, and ability to avoid physical settlement obligations. Synthetic futures allow market participants to gain futures-like exposure without tying up as much capital as outright futures contracts often require. 

This is particularly advantageous in markets like India, where margin rules for options spreads are often more favorable than those for outright futures positions.

One key benefit is the avoidance of physical delivery, which is common in commodity futures. With synthetic futures, settlement is always cash-based, eliminating logistical hassles and giving traders more control over their exposure. This is especially valuable for institutions that want price exposure but don’t want to deal with storage, transport, or regulatory paperwork.

Synthetic futures also provide a solution when actual futures contracts are expensive, illiquid, or unavailable. In these cases, constructing a synthetic position with liquid options markets ensures continuous access to the underlying asset’s price movements. 

During contract rollover periods, synthetic futures offer added flexibility, allowing traders to maintain exposure without being forced to exit and re-enter markets at inopportune times.

When to Use Synthetic Futures?

Synthetic futures are best used when direct futures trading is restricted, illiquid, or less efficient than options-based alternatives. 

For example, if a particular stock or commodity contract lacks sufficient futures volume, constructing a synthetic future with options provides reliable exposure without the risk of poor fills or excessive slippage.

They are also ideal when margin optimization is a priority. In India’s F&O markets, the combined margin for a synthetic future is often lower than the margin for an outright futures position, especially when using spread orders. 

This becomes even more significant for large portfolios that need to balance exposure, risk, and capital efficiency. By using synthetic futures, traders can replicate futures positions without affecting open interest or drawing regulatory scrutiny.

Another scenario is when options mispricing creates arbitrage opportunities. If the difference between call and put premiums deviates from theoretical values based on put-call parity, constructing a synthetic future lets traders capture risk-free profit. This is common during periods of market stress, quarterly expiries, or sudden shifts in demand for calls and puts.

What are the Pros and Cons of Synthetic Futures?

Synthetic futures offer the same linear payoff as real futures contracts, but come with unique advantages and disadvantages. One of the key benefits is their ability to replicate the exact risk/reward profile of a futures position using only options, which is especially useful when direct access to futures is limited due to regulatory, margin, or liquidity reasons. 

Synthetic futures provide powerful flexibility and capital efficiency for traders and hedgers, especially in illiquid or restrictive markets. But they demand advanced execution skills, constant monitoring, and awareness of both market liquidity and early exercise risks to maintain their benefits.

How Do Synthetic Futures Compare to Real Futures?

Synthetic futures and real futures provide similar market exposure, but differ in construction, margin, liquidity, and operational features. The synthetic future is built from options, while the real future is a standardized contract on an exchange. 

This distinction shapes their practical use and risk profile for traders and institutions. The main point of similarity is the payoff. Both instruments deliver a linear, symmetrical profit and loss curve based on the movement of the underlying asset. 

Execution is another area of contrast. Real futures are single-instrument trades, with high liquidity and narrow bid-ask spreads in most major contracts. Synthetic futures require simultaneous execution of a call and a put, which introduces more complexity and the potential for “legging risk”—where one leg fills and the other does not, causing slippage or unwanted exposure.

Liquidity vary significantly. While futures contracts on major indices or commodities enjoy deep order books, some stocks and smaller contracts are illiquid or unavailable. Synthetic futures, thanks to their construction from options, offer alternatives when futures liquidity is lacking, but options liquidity must also be checked for both legs.

Early exercise risk is present only in synthetic futures constructed from American-style options. This means the short leg can be exercised before expiry, breaking the synthetic structure and leading to unexpected positions. Real futures do not carry this risk, as positions remain until expiry or are closed out in the market.

How Do Option Greeks Affect Synthetic Futures?

Option Greeks have a direct impact on synthetic futures, shaping their price sensitivity and risk profile as market conditions change. The most important Greek for synthetic futures is delta, which measures the change in position value for a one-rupee move in the underlying asset. 

A synthetic long future—built from a long call and a short put, both at-the-money—delivers a delta close to +1, meaning it reacts to price changes almost identically to a real long futures contract. Conversely, a synthetic short future has a delta near -1, mirroring a short futures position.

Gamma, which measures how much delta changes for each move in the underlying, is minimal for a synthetic future held at-the-money. This is because the positive gamma of the long call and the negative gamma of the short put (or vice versa) generally cancel each other out. As a result, the delta of a synthetic future remains stable across small spot price movements, providing a consistent directional exposure.

Theta, the measure of time decay, is also largely neutral in a synthetic future at initiation. The time decay loss from the long call is offset by the time decay gain from the short put, making the overall synthetic position insensitive to the passage of time, as long as both options are equally close to the money and have the same expiry. This property sets synthetic futures apart from most other option strategies, which typically lose value as expiry approaches.

Vega, indicating sensitivity to implied volatility, is mostly neutral for synthetic futures constructed at-the-money. The increase in value of the call from a rise in volatility is offset by the decrease in value of the short put. 

Rho, the measure of sensitivity to interest rate changes, does have a small effect on synthetic futures. For instance, a rise in interest rates will generally increase the value of calls and decrease the value of puts, slightly impacting the cost to create or maintain a synthetic position. 

How Implied Volatility Affects Synthetic Futures?

Implied volatility influences the premiums of both options used in synthetic futures, but its effect often cancels out when the options are at-the-money and equidistant from the underlying price. 

The picture changes if there is a volatility skew or if the options selected are not perfectly at-the-money. Volatility skew occurs when out-of-the-money puts and calls trade at different implied volatility levels due to market demand or supply imbalances. 

In such cases, the cost to create a synthetic future may become higher or lower than the theoretical fair value, depending on which side of the skew the trader is on. This effect is particularly noticeable in markets with strong directional sentiment or when options are used to hedge large portfolios.

Implied volatility tends to rise during periods of market stress, which can temporarily inflate option premiums. If a trader enters a synthetic future in such an environment, the cost might be higher, and the position could lose value as volatility normalizes—even if the underlying asset does not move significantly. 

Monitoring implied volatility, and especially the relative movement between calls and puts, becomes crucial for timing the entry and exit of synthetic futures.

Are Synthetic Futures Profitable?

Yes, synthetic futures are profitable when used strategically to replicate futures exposure at a lower cost or more favorable margin. Traders and hedgers often turn to synthetic futures to take advantage of situations where the options market offers better pricing or where regulatory and margin rules make direct futures positions less attractive. 

Arbitrage opportunities occasionally arise when the pricing relationship between the futures and the options market diverges from the theoretical value set by put-call parity. In such scenarios, a trader can lock in risk-free profits by simultaneously buying or selling synthetic futures and the corresponding real futures contract, capturing the price difference as it converges. 

This practice is common among institutional traders and helps keep markets efficient.

Profitability also comes from the ability to optimize capital. By using option spreads that require lower margins, traders free up capital for other trades or investments, potentially increasing overall returns. 

This is especially relevant in Indian markets, where F&O margin frameworks sometimes favor certain options structures over outright futures, allowing sophisticated traders to manage large positions with less cash.