A great options story has been brewing in the past few weeks about how billionaire buy-out king Carl Icahn has been establishing a big stock position in Yahoo (NADSAQ: YHOO, Stock Forum) shares using options. The Wall Street Journal on May 16th highlighted Icahn’s position of 59 million shares of Yahoo stock that he created using only 9.9 million actual shares. “How can Mr. Icahn hold the rest without actually owning them?” the paper asked.

Well, this strategy might be news to most people, but to options traders it’s old hat. Icahn simply created 49 million shares of synthetic stock by buying 490,000 million call options on Yahoo stock and selling 490,000 million put options. If you caught the piece in the “Deals and Deal Makers” section, you might have noticed that the Journal incorrectly describes his trades as involving 49 million options. But to control 49 million shares of stock, you need only buy 490,000 option contracts since each option contract is equivalent to 100 shares of underlying stock. The paper obviously meant to say options worth 49 million shares, or something similar.

Now synthetic positions are how investors and traders can replicate the performance and returns of stock without owning any actual stock. Buying a call and selling a put, usually of the same exercise price and expiration, is equivalent to being long the underlying stock. The long call option grants the right to buy the stock at a certain price before expiration, if the stock goes higher. And the short put serves two purposes: first, selling the put helps pay for the cost of the call, and second, if the stock falls below the exercise price, or strike price, the holder of the short put position could be assigned and have the stock put to him. In other words, since he sold the right for someone else to be short the stock, if the long put holder decides to exercise their right, he will have to buy the stock at the strike price.

The synthetic option position doesn’t give Icahn the same rights as shareholders who own actual stock, like voting in corporate affairs or gaining a seat on the company’s board. But, the call options definitely give him the right to buy Yahoo stock at a certain price before they expire. And if he chooses to exercise these call options, he will become a large enough shareholder to throw his weight around concerning the company’s business.

We don’t care what he’s up to jumping in to the battle between Microsoft (NASDAQ: MSFT, Stock Forum) and Yahoo. We just want to know how and why he’s using options to do it. There are several interesting aspects to this particular synthetic options trade. Not only did Icahn create a cheaper way to control 49 million shares of Yahoo stock, by buying relatively inexpensive calls and financing them with short puts, he did so without the market noticing. If he had tried to buy the total 59 million shares of stock, lots of market players would have noticed and run the price up on him before he was done. But, large option trades like this can often be done quietly and under the radar.

Another interesting thing about this trade is that Icahn bought American-style call options, which can be exercised anytime before expiration, and he sold European-style put options, which can only be exercised, and force him to buy the stock, at expiration. We don’t know all the details of this trade, but the Journal does have price and contract information for the puts. They report that Icahn sold puts with a strike price of $19.50 and an expiration date of November 5th, 2010. The unique terms of this leg of the trade are the result of a customized deal between the billionaire and the investment bank who took the other side. This sort of deal is nothing new for him. Last year, Icahn used billions of dollars worth of options on Motorola (NYSE: MOT, Stock Forum) stock to gain a significant position and win board seats in the tech company. This strategy has one more benefit that dates back to the leveraged buy out-crazy 1980s. Big options positions used to gain control of big share positions are not regulated the in the same way by securities laws. Be sure to tune in to ONN.tv for more breaking options intelligence and education.