There are many variants of these seagull strategies, each of which provides a different risk–reward profile (and net cost). For example, for the portfolio manager wishing to hedge a long position in the base currency in the P/B quote when the current spot rate is 1.3550, another seagull structure would be to write an ATM call at 1.3550 and use the proceeds to buy an OTM put option at 1.3500 and an OTM call option at 1.3600. Note that in this seagull structure, the “body” is now a short option position, not a long position as in the previous example, and the “wings” are the long position. Hence, it is a long seagull spread. This option structure provides cheap downside protection (the hedge kicks in at the put’s 1.3500 strike) while providing the portfolio manager with unlimited participation in any rally in the base currency beyond the 1.3600 strike of the OTM call option. As before, the various option strikes and/or notional sizes on the options bought and written can be adjusted so that a zero-cost structure is obtained.
if I just take highlighted text
write an ATM call at 1.3550
Buy OTM call option at 1.3600
while providing the portfolio manager with unlimited participation in any rally in the base currency beyond the 1.3600 strike of the OTM call option
How does this provide unlimited protection? wouldn’t the ATM call strip away profits?
There are four ways to build each of these using combinations of options or the underlying plus options. I won’t enumerate all of these, but I’ll describe one way of creating each one. I’m limited in the pictures I can draw here, so I hope that the descriptions will suffice.
Long Bullish Seagull
Start with a bull spread (using calls or puts; your choice): _/¯. Add a long call with a strike that is higher than the high strike on the bull spread; this adds unlimited upside to the right of the upper flat portion of the payoff, at an increased cost over the bull spread.
Short Bullish Seagull
Start with a bull spread (using calls or puts; your choice): _/¯. Add a short put with a strike that is lower than than the low strike on the bull spread; this adds unlimited downside to the left of the lower flat portion of the payoff, but at a lower cost than the bull spread.
Long Bearish Seagull
Start with a bear spread (using calls or puts; your choice): ¯\_. Add a long put with a strike that is lower than the low strike on the bear spread; this adds unlimited upside to the left of the upper flat portion of the payoff, at an increased cost over the bear spread.
Short Bearish Seagull
Start with a bear spread (using calls or puts; your choice): ¯\_. Add a short call with a strike that is higher than the high strike on the bear spread; this adds unlimited downside to the right of the lower flat portion of the payoff, but at a lower cost than the bear spread.
Hi S2000,
Many thanks for your reply above and explanation of the different seagulls. Very helpful. I can see the structure of a bull/bear spread + a lower put/call option.
What I still don’t understand as per the original comment above, how can ‘writing an ATM call’ give you unlimited upside in the trade. For example see the below options sold and bought. What if the Share price ends as 1.38, you’ll have to sell it at 1.3550 - and yes you can buy it at 1.3600 but you need to still sell it to the buyer of your 1.3550 option, so technically you win 0.055 ct
@S2000magician - can you explain the unlimited downside in the short scenarios? If you are long a put with a strike lower than the low strike in a bear put spread wouldn’t you have limited upside with the long put? Prices can only go down to 0. I am missing something here. Care to clarify please?