Building blocks and synthetic configurations
The basic building blocks in the derivative world are the three contract types that we have just discussed. It is possible to combine any number of them in a configuration that has a desired payoff profile.
A user can combine any two of the above three products to synthetically create the third. For example we can combine calls and puts to synthetically create both long and short forward contracts.
|Product A||Product B||= Product Three|
|Long Call||Short Put||Long Forward|
|Long Put||Short Call||Short Forward|
The concept in the above table is illustrated in the following three diagrams.
Comparing a Call with a Forward contract
Comparing a Call and a Put with a Forward contract
Combining a long call with a short put to create a long forward
Addendum: What is wrong with the payoff profile of the synthetic forward?
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