Synthetic Covered Call Strategy Explained

Options strategies come in all shapes and sizes, but many serve a similar purpose: generating income while managing risk. Covered calls are perhaps the most well-known income strategy for investors holding stock positions. But what if you want the same income benefits without tying up a large chunk of capital?

Synthetic Covered Call, a capital-efficient strategy that mimics the payoff of a traditional covered call using only options. This approach is especially useful for intermediate traders, those who don’t own 100 shares of stock, or anyone exploring income-generating tactics like the Poor Man’s Covered Call (PMCC).

In this article, we’ll break down what synthetic covered calls are, how they work, and when they might be a smart addition to your trading toolkit. Before we proceed, let’s answer a common misconception. 

The difference between Synthetic Covered Call and Poor Man’s Covered Call (PMCC) 

A Poor Man’s Covered Call (PMCC) is technically a diagonal spread, meaning the long and short call options have different expiration dates. It typically uses a deep in-the-money long call with a high delta, which makes it behave more like owning the stock itself.

In contrast, a Synthetic Covered Call follows the same basic idea using a long call and selling a short call but it offers more flexibility. You can choose a less deep in-the-money long call and adjust how closely it mimics the stock depending on your strategy. It's more customizable, while PMCC is more structured.

The concept remains the same, only the set up differs. 

The components of a Synthetic Covered call Strategy

Long Call (LEAP)

• You buy a deep ITM call say, a $60 strike when the stock is trading at $100
• Expiration is typically 6–12 months out
• This option mimics stock ownership due to its high delta (≈ 0.80–0.95)

You might be wondering what's the catch here? After all, you're paying $60 for an option on a stock that's currently trading at $100. That’s the trade-off when buying a deep in-the-money (ITM) call. The high delta comes with a premium, reflecting how closely the option mimics actual stock ownership.

Short Call (Near-Term)

• You sell a short-term OTM call
• Strike is typically above the current price (e.g., $105 when the stock is $100)
• This generates income through premium collection

Together, these two legs create a payoff profile similar to a covered call—but capital-efficient.

Delta Explained:
Delta measures how much the option price moves relative to the stock. A delta of 0.85 means the option behaves 85% like the underlying stock. The higher the delta, the more your LEAP call mimics owning actual shares.

Example of a Synthetic Covered Call

Let’s look at how this might work in practice.

Setting up the Synthetic Covered Call

Let’s say Stock XYZ is currently trading at $100. You decide to buy a LEAP call with a $60 strike price that expires in one year, paying a premium of $45. At the same time, you sell a 30-day call option with a $105 strike price and collect a premium of $1.50.

Outcome 1: Stock stays under $105

• The short call expires worthless
• You keep the $1.50 premium income
• Your long call retains value if the stock remains above $60
  
  

Outcome 2: Stock rises above $105 (say, hits $120)

• The short call is exercised
• You are “obligated” to sell at $105, but your long $60 call gives you the right to buy at $60
• Net profit:
  
  
  • $105 – $60 = $45 intrinsic gain
  • Assuming a $1.50 premium
  • – $45 (LEAP cost)
  • Total profit ≈ $1.50
    
    

Just like a covered call, the profit is capped but you earned income with less capital upfront.

You can now see how a high Delta influences both your profit potential and breakeven point in a synthetic covered call. And since you don’t actually own the shares, you also miss out on benefits like dividends and shareholder rights that come with stock ownership.

So Should you use a Synthetic Covered Call? 

Synthetic covered calls are a creative way to generate income without tying up large capital in shares. They're ideal for traders who understand options mechanics

Just remember: this is still an advanced options tactic. If you're not comfortable managing assignment, rolling positions, or tracking theta decay—it might be best to start with traditional covered calls.

Another common misconception, Synthetic Covered Calls and Synthetic Calls

A common point of confusion among traders is the difference between synthetic covered calls and synthetic calls. These are entirely different strategies with distinct objectives. A synthetic long call involves combining a long stock position with a long put; it's a directional strategy used to replicate the behavior of a standard call option, typically when the trader has a bullish outlook. 

In contrast, a synthetic covered call consists of a long call (usually a LEAP) paired with a short call, and is designed as an income strategy for neutral to moderately bullish markets. While both use options to replicate certain payoffs, their structures and purposes are fundamentally different.