What Is a Synthetic Covered Call?
A synthetic covered call replicates the risk-reward profile of a traditional covered call without owning the underlying stock shares. Instead of buying 100 shares and selling a call, you buy a deep in-the-money call option (which acts as a stock substitute) and sell a higher-strike call against it. This creates a diagonal spread that behaves similarly to a covered call but requires significantly less capital, typically 25-35% of what shares would cost.
The synthetic covered call is functionally equivalent to a poor man's covered call (PMCC) and is built using options that have different strikes and potentially different expiration dates. The long call should have a delta of 0.80 or higher so it moves nearly dollar-for-dollar with the stock. The short call is sold at a higher strike, generating premium income just like a traditional covered call. The strategy is popular among traders who want covered call income but cannot afford to buy 100 shares of high-priced stocks.
A synthetic covered call on a $100 stock might cost $2,500-$3,000 in capital (long call cost minus short call premium) vs. $10,000 for 100 shares. This 70-75% capital reduction amplifies your return on investment for the same premium income.
Synthetic vs. Traditional Covered Call
| Feature | Traditional | Synthetic |
|---|---|---|
| Capital required | 100 × Stock Price | Long Call Cost - Short Premium |
| Typical savings | — | 60-75% less capital |
| Dividends | Yes | No |
| Time decay on long leg | No | Yes (LEAPS decay slowly) |
| Max loss | Stock to zero + premium | Long call cost - short premium |
| Assignment risk | Simple (deliver shares) | Complex (exercise long call) |
| Margin requirement | None (shares cover) | Spread margin |
- 1Net debit = $28.00 - $3.00 = $25.00 per share
- 2Capital required = $25.00 × 100 × 2 = $5,000
- 3Capital for shares = $100 × 100 × 2 = $20,000
- 4Savings = 1 - ($5,000/$20,000) = 75%
- 5Max profit = ($105 - $75 - $28 + $3) × 100 × 2 = $1,000
- 6Breakeven = $75 + $28 - $3 = $100
- 7Annualized return = ($1,000/$5,000) × (365/30) = 243%
Building a Synthetic Covered Call
Construction Steps
- Synthetic covered calls offer 3-4x leverage compared to traditional covered calls
- No dividends are received (this is the main disadvantage)
- The long LEAPS option slowly decays, reducing position value over time
- Best suited for high-priced stocks where buying shares is capital-prohibitive
- Tax treatment differs from traditional covered calls (consult a tax professional)
- Risk of total loss if stock drops below long call strike at LEAPS expiration
Unlike stock which always has some value, your long call can expire worthless if the stock drops below its strike price. This represents a total loss of the long call investment. Always set a stop-loss and close the position if the stock declines 15-20% below the long call breakeven.