The Synthetic FX Options Strategy replicates the payoff of a currency position or traditional options structure by combining spot forex trades with vanilla options, or blending two or more options to simulate directional or non-directional exposure. This strategy is commonly used by institutional traders, banks, and experienced forex traders who seek customised risk-reward profiles, often with lower cost or greater flexibility than standard options contracts.

Synthetic strategies allow traders to:

• Hedge without full exposure
• Construct directional or neutral positions
• Mimic long/short currency positions using options only

What Is a Synthetic Position in FX?

A synthetic position is created by combining two instruments to replicate the payoff of another. In FX, this usually involves:

• Combining calls and puts
• Using options plus spot
• Building structures like synthetic longs/shorts, straddles, or strangles

Key examples:

• Long Call + Short Put = Synthetic Long
• Short Call + Long Put = Synthetic Short

These positions behave like holding the underlying currency directly, but with defined risk and different margin requirements.

Strategy Objective

• Use options to replicate spot or futures positions
• Create cost-efficient hedges or directional plays
• Gain exposure to currency moves without full capital outlay
• Exploit volatility or interest rate differences between currencies

Core Synthetic FX Strategies

1. Synthetic Long FX Position

Setup:

• Buy a call option
• Sell a put option at the same strike and expiry
• Simulates being long the underlying currency pair

Use case: Bullish outlook with option-style capital efficiency

2. Synthetic Short FX Position

Setup:

• Sell a call option
• Buy a put option at the same strike and expiry
• Simulates being short the underlying pair

Use case: Bearish directional exposure without spot position

3. Synthetic Forward Contract (Delta-Neutral Hedge)

Setup:

• Combine spot trade with option to lock in forward rate
• E.g., Long EUR/USD spot + Long EUR/USD put = synthetic forward sale
• Common for exporters or firms managing currency risk

Use case: Lock in exchange rate at future date with flexible exposure

4. Synthetic Straddle or Strangle

Straddle:

• Buy a call and a put at the same strike and expiry
• Profits from large move in either direction

Strangle:

• Buy OTM call and OTM put (wider strikes)
• Cheaper than straddle, needs larger move

Use case: Expecting volatility without directional bias (e.g. ahead of central bank decisions)

5. Risk Reversal (Synthetic Insurance)

Setup:

• Buy a call and sell a put (or reverse)
• Construct bullish or bearish exposure at zero or low cost
• Often used in hedging portfolios or enhancing carry trades

Use case: Bullish exposure with cost control and skew exploitation

6. Synthetic Covered Call

Setup:

• Long spot FX position
• Sell a call option
• Earn premium while holding currency

Use case: Enhance yield or hedge upside in slow markets

Step-by-Step Guide: Synthetic Long EUR/USD

Step 1: Bullish on EUR/USD, but prefer options to spot

• Buy 1-month 1.0800 Call
• Sell 1-month 1.0800 Put
• Net cost = near zero or small premium received

Step 2: Monitor delta

• Delta ~ +1 = similar to long spot EUR/USD
• Adjust position if price deviates significantly

Step 3: Exit before expiry or manage via rolling

• Can close early if directional target hit
• Or allow to expire and settle synthetically

Advantages of Synthetic FX Strategies

• Capital efficiency: lower margin than spot or futures
• Customisable exposure: control over delta, gamma, theta
• Defined risk: especially with long option legs
• Useful in volatile or uncertain markets
• Exploit skew and volatility differences

Risks to Consider

• Premium costs: buying options involves upfront payment
• Assignment risk: especially with short options
• Complex pricing: requires understanding of Greeks
• Expiry risk: positions decay over time
• Slippage: wide spreads in exotic or illiquid pairs

Best Use Cases

• Hedging business or investment currency exposure
• Replacing leveraged spot trades with defined-risk positions
• Expressing views on central bank policy, inflation, or geopolitical moves
• Trading volatility in event-driven environments (e.g. NFP, CPI)

Conclusion

The Synthetic FX Options Strategy gives traders the power to tailor their currency exposure with precision, flexibility, and risk control. Whether building synthetic long/short positions, hedging future cash flows, or trading volatility, these tools unlock a new dimension of forex trading sophistication.

To master synthetic FX structures and integrate them into a professional risk-managed trading plan, enrol in our advanced Trading Courses and learn to trade currencies with institutional-level insight and control.