In this article I will show how to create Covered Call, Cash Secured Put, and Bullish Seagull positions.
Each example will use XLK options expiring on 9/11/20, with prices as of 8/14/20
Standard Covered Call
Formula = Long Stock + Short Call
First let's look at a risk graph for a Long Stock position. Here you can see that there is unlimited downside risk and unlimited upside potential.
Selling an OTM call will create a Covered Call position, since the call is covered by the stock position. Here the downside risk remains the same, however the upside potential is capped by the strike price of the sold call. So for the benefit of the premium collected on the call, which reduces your cost basis, you give up some upside potential.
Synthetic Covered Call
Formula = Synthetic Long Stock (Long Call + Short Put) + Short Call
Using options only, you can create a Synthetic Long Stock position by buying a call and selling a put at the same strike. This has the same risk profile as Long Stock, but at a lower cost, and in some cases at no cost or a net credit.
Selling an OTM call will create a Synthetic Covered Call position, since the short call is covered by the long call (i.e Bull Call Spread). Again, downside risk remains the same, and upside potential is capped. However, this trade is less capital intensive than a Standard Covered Call.
Cash Secured Put
Formula = Short Put
Instead of creating either variation of Covered Calls, you could just sell an OTM Cash Secured Put to replicate the risk profile. This is the simplest option (pun intended).
Bullish Seagull
Formula = Short Put + Long Call + Short Call
Formula = Synthetic Long Stock Split Strike (Long Call + Short Put) + Short Call
Formula = Cash Secured Put (Short Put) + Bull Call Spread (Long Call + Short Call)
In the Synthetic Long Stock position example above, the call/put were bought/sold at the same strike. However, you can buy/sell at different strikes, which creates a Synthetic Long Stock Split Strike position. This position is less aggressive and has more downside protection, but at a cost (i.e. net debit vs net credit).
Selling an OTM call will create a Bullish Seagull, which I described here.
Conclusion
There are many ways of combining options to create positions with similar risk profiles. I encourage you to try this for yourself and see what you can come up with.
I hope you found this useful.
