What are the characteristics of this option strategy?
Seagull spreads are an advanced, high risk option structure built from three legs in the same expiration: a long out-of-the-money call, a short further out-of-the-money call above it, and a short out-of-the-money put below the market. The two calls form a long call spread, which caps the upside, and the short put finances it, usually leaving a net credit. The strategy has positive theta (time decay) and negative vega (volatility). The short put is uncovered, so the loss on the downside is not capped by any other leg and runs all the way to a stock price of zero.
Is this a bullish, bearish or neutral strategy?
The Seagull Option Strategy as constructed here is a bullish strategy: the long call spread gives it positive delta on the upside, and the short put means the trader is willing to be long the stock below the put strike.
Is this a beginner or an advanced option strategy?
The Seagull Option Strategy is an advanced strategy due to its complexity, the magnitude of the capital requirement and the level of risk involved. The naked short put needs uncovered option margin approval and enough buying power to take delivery of the shares at the put strike.
In what situation will I use this strategy?
This strategy should be considered when the investor is mildly bullish on the underlying, the options market is pricing high implied volatility so the short put pays well, and the investor is genuinely willing to own the stock at the put strike. If that last condition is not true, the trade should not be put on: assignment on the short put is the normal outcome of a fall, not an edge case.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The probability of profit is high, because the position wins across a wide band of outcomes: anywhere from the short put strike upward. The reward, though, is strictly capped at the net credit plus the width of the call spread, while the loss on the downside is open-ended. That is the classic profile of a strategy that wins often and small and loses rarely and large. Time decay works for the position rather than against it, so theta is a help, not a risk. The risk is the uncovered short put.
How is this strategy affected by the greeks?
The Seagull Option Strategy has positive theta, meaning it profits from time decay, and negative vega, so a jump in implied volatility hurts it. Delta is positive, giving the position a bullish tilt. The greek that matters most in a bad tape is gamma on the short put: as the underlying falls toward the put strike, delta grows quickly and losses accelerate rather than level off.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The Seagull Option Strategy is most suitable when the underlying asset has high implied volatility, because the short put is where most of the credit comes from. A reasonable filter is implied volatility above the 50th percentile of its own one-year range. Note the tension: rich put premium usually means the market is pricing a real chance of a sharp fall, and that fall is exactly what this position is exposed to.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
The trade goes against you when the underlying falls toward the short put, and adjusting from there is neither cheap nor easy. Buying the short put back once it is at or in the money costs far more than the credit originally collected, so the adjustment locks in a loss. The alternatives are buying a further out-of-the-money put to convert the naked put into a defined-risk put spread (which should ideally be done at entry, not after the fall), rolling the short put down and out for a smaller further credit while extending the exposure in time, or accepting assignment and owning the stock at the put strike. Plan the downside before entering, because the useful adjustments are the ones made in advance.
Where does this strategy typically fall in the range of commissions and fees?
Since the Seagull Option Strategy involves three legs rather than one or two, the cost of commission and fees is higher than that of a simple option trade. At roughly $1 per contract per leg, a single seagull costs about $3 to open and the same again to close, which is worth weighing against a credit that is usually only a few dollars per share.
Is this a good option income strategy?
It collects a credit and has positive theta, so it is often used as an income strategy, but the income is paid for with an uncapped downside. Selling a naked put every month produces a run of small wins and then one loss that can wipe out several years of them. If it is used for income, the short put should be sized as though the shares will actually be assigned, and pairing it with a long put further out of the money turns the tail risk into a defined amount at the cost of some of the credit.
How do I know when to exit this strategy?
Decide the exit before entering. A common approach is to close the position once most of the credit has decayed, for example when it can be bought back for 20% to 30% of what was received, rather than holding for the last few cents while the naked put stays exposed. The other exit is a stop on the underlying: if it breaks down toward the short put strike, close or roll rather than waiting to see whether it recovers, because the loss below that strike grows without limit.
How will market makers respond to this trade being opened?
Since market makers are gambling on the option prices in order to remain solvent, they use sophisticated computer models that automatically detect options strategies, such as the Seagull Option Strategy. When they spot this strategy, they will hedge positions in order to reduce their risk.
What is an example (with calculations) of this strategy?
Assuming MSFT is trading at $285, an investor can create a Seagull Option Strategy by simultaneously buying an out-of-the-money call, selling a further out-of-the-money call above it, and selling an out-of-the-money put below the market, in order to produce a net credit.
To execute this strategy, the investor would do the following:
Buy one out-of-the-money call option with a strike price of $290 and an expiration date of one month from now, paying a premium of $5 per share.
Sell one out-of-the-money put option with a strike price of $275 and an expiration date of one month from now, receiving a premium of $7 per share.
Simultaneously, sell one out-of-the-money call option with a strike price of $300 and an expiration date of one month from now, receiving a premium of $3 per share.
The net credit is $7 + $3 - $5 = $5 per share, or $500 for one contract of each leg. The resulting payoff diagram has a flat body across the middle, a short rising step between the two call strikes, and a left wing that falls away without a floor below the put strike.
Here’s how the strategy works:
If MSFT’s price rises above the strike price of $300 by the expiration date, the call spread is at its full width of $10 per share. Added to the $5 credit, that is the maximum profit on the trade: $15 per share, or $1,500 per contract. Gains stop there no matter how high MSFT goes, because the short $300 call gives back everything the long $290 call earns above that level.
If MSFT’s price finishes between $290 and $300, the long $290 call is in the money and the short $300 call is not, so the position earns the $5 credit plus however far MSFT is above $290, up to the $15 maximum.
If MSFT’s price finishes between $275 and $290, all three options expire worthless and the investor simply keeps the $5 per share credit, or $500 per contract.
If MSFT's price falls below the strike price of $275 by the expiration date, the investor is assigned on the short put and must buy MSFT at $275. Both call legs expire worthless below $290, so nothing offsets this loss beyond the $5 net credit: the downside breakeven is $270, and below it the position loses $100 for every $1 MSFT falls, up to roughly $27,000 per contract in a move to zero. The short put is uncovered and this is the dominant risk in the trade.
MarketXLS
MarketXLS is a great tool that can help you with option trades, such as the Seagull Option Strategy. The MarketXLS platform includes extensive data set linked to financial models using Excel and it enables investors to create strategies and analyze hypothetical trades in order to identify trading opportunities. MarketXLS also provides access to US stocks options chains, futures, world index options, custom option chains and more.
Here are some templates that you can use to create your own models
Search for all Templates here: https://marketxls.com/templates/