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Poor Man's Covered Call

Overview

Ever wanted to run a covered call strategy but didn't have the capital to buy hundreds of shares of your favorite stocks? Enter the Poor Man's Covered Call (PMCC) – the budget-friendly alternative that lets you play in the options income game without breaking the bank.

Despite its somewhat unfortunate name, there's nothing "poor" about the strategy's potential. It's actually a clever diagonal spread that mimics a traditional covered call by substituting a long-term deep in-the-money call option (often called a LEAPS) for the stock itself. Think of it as getting the benefits of stock ownership at a fraction of the cost, while still collecting those sweet call premiums along the way.

Key Characteristics

  • Market Outlook: "I'm bullish on this stock long-term, but I'd like to generate some income while I wait"
  • Risk: Limited to the cost of the LEAPS call option (much less than owning the actual stock)
  • Profit Potential: Premium income from short calls plus potential appreciation of the LEAPS call
  • Breakeven Points: LEAPS strike price + LEAPS premium paid - premiums collected from short calls

When to Use

The Poor Man's Covered Call might be your go-to strategy when:

  • You want to run a covered call strategy but don't have enough capital to buy 100 shares outright
  • You're bullish on a stock over the long term but want to reduce your cost basis through premium collection
  • You want to limit your downside risk compared to owning the actual stock
  • You're looking for a strategy with better capital efficiency and potentially higher ROI than traditional covered calls
  • You want the flexibility to adjust your position as market conditions change
  • You're comfortable with a slightly more complex options strategy than a basic covered call

Real-World Example

Let's walk through a concrete example to see how this works in practice. Imagine XYZ stock is currently trading at $100 per share.

  • Step 1: Buy the LEAPS Call Option
  • Instead of buying 100 shares of XYZ for $10,000, you purchase a deep in-the-money LEAPS call with a $70 strike price expiring in 12 months for $35 per share ($3,500 for the contract)
  • This LEAPS option has a delta of approximately 0.80, meaning it behaves very similarly to owning 80 shares of the stock
  • You've just saved $6,500 in capital compared to buying the shares outright!
  • Step 2: Sell Short-Term Call Options
  • Now you sell a call option with a $105 strike price (slightly out-of-the-money) expiring in 30 days for $3 per share ($300 for the contract)
  • This is your first premium collection – the income part of the strategy
  • Step 3: Manage the Position
  • If XYZ stays below $105 at expiration, your short call expires worthless, and you keep the entire $300 premium
  • You can then sell another call for the next month and continue collecting premiums
  • If XYZ rises above $105, you have options: you can roll the short call up and out, or you can close the entire position for a profit
  • Let's say you're able to sell calls for 10 months, collecting about $300 each time for a total of $3,000 in premium income
  • That's a return of 85.7% on your initial $3,500 investment just from premium collection!
  • And if XYZ appreciates during that time, your LEAPS call will increase in value as well

The beauty of the PMCC is that you're getting similar benefits to a traditional covered call but with much less capital at risk and potentially higher percentage returns. It's like getting the keys to a luxury car by just paying for the down payment instead of the full sticker price.

The Good Stuff

  • Significantly lower capital requirement than a traditional covered call (often 20-40% of the stock price)
  • Limited downside risk – you can only lose what you paid for the LEAPS option
  • Higher potential ROI due to the lower capital outlay
  • Ability to generate consistent income through selling calls against your LEAPS position
  • Leverage – the LEAPS call gives you exposure to 100 shares for a fraction of the cost
  • Flexibility to adjust your position as market conditions change
  • Can be used on higher-priced stocks that might otherwise be out of reach

The Not-So-Good Stuff

  • More complex than a traditional covered call – requires understanding diagonal spreads
  • The LEAPS option loses value over time (time decay), unlike owning the actual stock
  • No dividend income (unlike owning the actual shares)
  • Assignment risk if your short call goes in-the-money (requires careful management)
  • Potentially higher transaction costs due to managing multiple options
  • Requires more active management than a traditional covered call
  • Bid-ask spreads on LEAPS can be wider, potentially increasing your entry/exit costs

Playing It Smart

  • Choose LEAPS with at least 9-12 months until expiration to minimize the impact of time decay
  • Look for LEAPS with a delta of 0.70 or higher to closely mimic stock ownership
  • Select a LEAPS strike price that's at least 10-15% in-the-money for stability
  • Sell short-term calls with strikes above your LEAPS strike to maintain a positive spread
  • Be mindful of earnings announcements and other major events that could cause significant price swings
  • Consider closing or rolling your short calls if they approach being in-the-money to avoid assignment complications
  • Have an exit plan for your LEAPS – either roll it forward when it has 3-4 months left or close the entire position
  • Track your cost basis carefully – each premium you collect effectively reduces your cost in the LEAPS
  • Start with stocks you understand well and that have liquid options markets