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 Call Option?25 Views
finance a la shmoop. what is a call option? option? option, where are you? okay
yeah yeah. not phone options, call options. and a close but no cigar. a call option [man smokes in a tub of cash]
is the right to call or buy a security. the concept is easy the math is hard.
you think Coca Cola's poised for a breakout as they go into the new low
calorie beverage business. their stock is at 50 bucks a share and you can buy a [man stands on a stage as crowd cheers]
call option for $1. well that call option buys you the right
to then buy coke stock at 55 bucks a share anytime you want in the next
hundred and 20 days. so let's say Coke announces its new sugarless drink flavor
zero it's two weeks later and the stock skyrockets to fifty eight dollars a
share. you've already paid the dollar for the option now you have to exercise it. [man lifts weights]
so you buy the stock and you're all in now for fifty five dollars plus one or
fifty six bucks a share and your total value is now fifty eight bucks. well you
could turn around today and sell the bundle that moment, and you'll have
turned your dollar into two dollars of profit really fast. and obviously had the [equation on screen]
stock not skyrocketed so quickly well you would have lost everything. still you
lucked out and now you're sitting on some serious cash, courtesy of your call [two men in a tub of cash]
options. as for Coke flavor zero turned out to be nothing more than canned water.
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A derivative of a security is a "something" which derives its value based on the performance of that security... either a put option or a call option.
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