SteadyOptions is an options trading forum where you can find solutions from top options traders. Join Us!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

The Synthetic Covered Call Options Strategy Explained

Synthetic positions in options trading is the use of options and/or stocks in order to produce positions that are equivalent in payoff characteristics as another totally different position. So, can we to produce the payoff characteristics of one of the most popular options strategies, the Covered Call, without buying the underlying stock?

The answer is the Synthetic Covered Call.

What Is A Synthetic Option Strategy?

A synthetic covered call is an options position equivalent to the covered call strategy (sold call options over an owned stock). It consists of a sold put option.

Synthetic options strategies use bought and sold call and put options to mirror the payoff, risks, and rewards of another strategy, often to reduce complexity or capital requirements.


For example, suppose a stock, ABC, is trading at $100. Buying 1000 shares would be expensive ($100,000 or perhaps $50,000 on margin).


The same risk and rewards can be achieved by buying an at the money call option (strike price 100) and, simultaneously, selling an at the month put option (exercise price 100).


How do we know these are the same trade? By looking at their pay off diagram. It is a fundamental point of options theory that if the payoff diagrams of two strategies are the same, over time, they are the same position.


Here’s the stock pay off diagram:

This image has an empty alt attribute; its file name is long-stock-1024x669.jpg



And the ‘synthetic stock’:

This image has an empty alt attribute; its file name is synthetic-long-stock-1024x669.jpg


These are identical and don’t deviate over time (in fact the payoff diagrams don’t change at all over time – both positions are theta neutral) and so are the same.


But why would you put on this synthetic position? Because it potentially requires much less capital: owning a call option (just the premium) and being short a put option (just any margin requirement) requires less cash up front.


What Is A Covered Call?

We’ve covered this elsewhere, but a covered call is one of the most popular option strategies.


It involves a short call option – usually out of the money – against an owned long stock position.


It’s popular with stockholders wishing to generate income on their portfolio. Selling, say, monthly out of the money (OTM) call options against their stock positions for option premium is attractive, particularly in these low yielding times.


Their only risk that their stock gets called away – the stock rises above the sold call strike price on expiry. But even in this scenario the stockholder would still profit – but not by quite as much as if they had not sold the share.


Let’s look to an example.


An investor owns shares in XYZ, trading at $50 a share, and decides to sell 1 month call options with a strike price of $50, over this holding, receiving premium of $5 a share. This is the classic covered call.


Should the stock be below $50 in a month, the investor keeps the $5.


If the stock rises above $50 their shares would be called away – in effect sold at $50 at zero profit or loss plus the $5 premium.


The only ‘loss’ would be if the price rose over $50 – $60, say. Then the $10 rise would be lost as the investor must sell their shares for $50 rather than $60.


Here’s the payoff diagram:

This image has an empty alt attribute; its file name is covered-call-1-1024x669.jpg


Many investors believe this loss of potential upside a price worth paying for the chance to enjoy monthly option premiums against already held shares.


Why Put On A Synthetic Covered Call?

The question then arises – why both trying to recreate the covered call strategy if it works so well?


The answer is, of course, that you may not own the shares. Our investor above already owned the shares. What if you don’t?


Well, you could buy the shares and then sell the calls as above. But that requires a significant outlay of capital. What if there was a way to replicate the above whilst reducing this capital requirement to something more reasonable?


That’s where the synthetic covered call comes in.


How To Construct A Synthetic Covered Call

This is much simpler than you might think. It simply involves selling at the money put options.


Let’s go back to our example.


This involved owned stock and sold calls with a $50 strike price.


We can replicate this by simply selling puts at $50. Note that you don’t need to own the stock (they are so called ‘naked’ puts) and that the puts are at the money with the stock trading at $50.


Here’s the payoff diagram:

synthetic covered call


Notice that it’s identical to the covered call above.


And therefore, using the principle above, the strategies are the same.


Advantages Of The Synthetic Covered Call

We’ve mentioned the main reason before: there is no need to own the stock thus, potentially, reducing the position’s capital requirements.


Disadvantages Of The Synthetic Covered Call

A ‘naked’ put is very risky: it has almost unlimited downside risk. Should the underlying stock fall heavily losses could be substantial.


The position is Vega negative: a rise in volatility would work against position. Unfortunately, the most likely reason for a rise in implied volatility is a sharp fall in stock price – thus exacerbating the losses caused by such a fall.


The possibility of large losses could mean that brokers do not allow you to place naked options positions or require a significant margin.


Indeed, many options brokers would only consider a cash-secured put write: sufficient cash held to buy the stock should the put expire in the money. This eliminates the main driver for the position: capital requirements.


Unlike the covered call the investor would not receive any dividends paid by the underlying stock.


Other Points To Note

One Way To Reduce Risk

It is possible to reduce the risk of the synthetic covered call by buying an out of the money put when initiating the trade.


This turns the trade into a bull put spread which, as a covered rather than naked position, has a much lower broker margin requirement.


It does, however, reduce the net premium earned which may be significant.


An Alternative: The LEAP Covered Call

An alternative way to reduce the capital requirements of a covered call is to buy a deep in the money  LEAP  call (ie a long dated call option) in place of the stock, but at a much lower capital requirement.


OTM LEAPs have deltas close to 1, and hence behave similarly to the underlying stock. Short dated call options can be sold regularly over the LEAP as though it was the stock.


The disadvantage is that LEAPs, unlike stocks, have some intrinsic value which is subject to time decay. All things being equal they will lose value over time (they are theta positive) albeit slowly.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.


What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Real-time trade sharing: entry, exit, and adjustments

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Subscribe to SteadyOptions now and experience the full power of options trading!

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles


  • Diagonal Spread Options Strategy: The Ultimate Guide

    A diagonal spread is a modified calendar spread involving different strike prices. It is an options strategy established by simultaneously entering into a long and short position in two options of the same type—two call options or two put options—but with different strike prices and different expiration dates.

    By Kim,

  • Gamma Scalping Options Trading Strategy

    Gamma scalping is a sophisticated options trading strategy primarily employed by institutions and hedge funds for managing portfolio risk and large positions in equities and futures. As a complex technique, it is particularly suitable for experienced traders seeking to capitalize on market movements, whether up or down, as they occur in real-time.

    By Chris Young,

  • Why New Traders Struggle: 3 Key Concepts New Traders Never Grasp

    Everyone knows the statistic - 95% of traders fail. Whether or not that's an accurate statistic, it's certainly true that few that attempt trading ever make life-changing money. Part of that is because most don't take it seriously. But what about those that do and fail?


    By Pat Crawley,

  • Long Call Vs. Short Put

    In options trading, a long call and short put both represent a bullish market outlook. But the way these positions express that view manifests very differently, both in terms of where you want the market to go and how your P&L changes over the life of the trade.

    By Pat Crawley,

  • 12 Tips For Building Long-Term Wealth

    Building wealth is a lifelong aspiration for many people, yet it’s frequently regarded as reserved for a select few. However, this perception is not entirely true, especially when it’s possible to accumulate wealth and live an abundant life.

    By Kim,

  • Retirement Strategies for Senior Citizens to Grow and Protect Their Wealth

    Retirement is a time of life that many people look forward to, but it requires careful planning and preparation. One of the most important aspects of preparing for retirement is calculating your retirement needs and starting to save early. In this section, we will discuss some key points to consider when planning for your retirement.


    By Kim,

  • What is a Seagull Option Spread?

    A seagull option spread involves adding an additional short option to a vertical debit spread to reduce the net debit paid, often enabling you to enter a trade for zero cost. The name is derived from the fact that the payoff diagram has a body and two wings, imitating a seagull.

    By Pat Crawley,

  • The Options Wheel Strategy: Wheel Trade Explained

    The “wheel” trade is variously described as a beginner’s strategy, a combination to exploit features of both calls and puts, and as “perfect” solution to the well-known risks of shorting calls, even when covered. The options wheel strategy is an income-generating options trading strategy that both beginners and experienced traders can leverage for profit.

    By Pat Crawley,

  • Covered Calls Options Strategy Guide

    Covered calls have always been a popular options strategy. Indeed for many traders, their introduction to options trading is a covered call used to augment income on an existing stock portfolio. But this strategy is more complicated, and riskier, than it looks.

    By Chris Young,

  • The Best Retirement Savings Plans For Every Age And Income Level

    Saving for retirement can be challenging. You have to start thinking about it decades in advance and dedicate significant time and energy to the optimal strategy. Just trying to wing it and seeing what happens won’t usually work. 

    By Kim,


  Report Article

We want to hear from you!

There are no comments to display.

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now

Options Trading Blogs Expertido