Poor Man’s Covered Call Explained – The Best Options Strategy?

Poor-Mans-Covered-Calls-Strategy

Not all of us can afford to sell Covered Calls, i.e. buying 100 or more shares of a stock and sell Call options against them. Instead, the Poor Man’s Covered Call strategy allows the investor to reduce both the risk and the capital needed to sell covered calls. The idea is pretty simple, and here its summary;

  • Buy an in-the-money (ITM) long-dated (4+ months out) call option
  • Sell an out-of-the-money (OTM) short term (weekly) call option

# Possible outcomes depending on the underlying stock’s price:

  • The Stock Remains Flat: You had sold the (short term) call option at a premium of $100. The underlying stock’s price remained flat, therefore the price of the option decreased to $20. Now you buy back the option you sold (or let it expire), and you have earned the difference: $80.

 

  • The Stock Goes Up: You had sold the (short term) call option at a premium of $100. The underlying stock’s price increased, therefore the option you sold is ITM. Now you have to buy it back using cash on-hands, or you can close the long-dated call option you bought, to cover the option you sold. In that case, you have lost, yet not that much, because the long-dated call you have, has increased also (but not as much as the short-term option, due to the gamma).

 

  • The Stock Goes Down: You had sold the (short term) call option at a premium of $100. The underlying stock’s price decreased, therefore the option you sold will probably expire OTM. Now you have earned all of the premia on the option you had sold, but your long-dated call lost value due to the decrease in the stock’s price. In total, your profit/loss depends on how much the stock’s price fell.

 

# The Idea Behind Buying long-dated Call and Selling short-dated Call

A long deep in-the-money (ITM) call option acts like a stock due to its high Delta. The high Delta ensures the option’s price moves as close to the stock’s price as possible. The further the expiration date, the more the option’s price resembles the stock’s price. Do note that you will be paying more for time decay, so longer LEAPS will be more expensive. These long-dated options also called “LEAPS” (Long-term Equity Anticipation Securities). The first step in the Poor Man’s Covered Call strategy is to choose an appropriate LEAPS contract to replace buying 100 shares of the stock you wish to trade. This will be used to cover the calls you will sell later.

The next step in the Poor Man’s Covered Call strategy is to sell a weekly out-of-the-money (OTM) call option. That’s how you will earn premia for selling an option, while “having” the underlying stock (by holding the long-dated call option you bought earlier).

After you’ve done that, the best scenario you can wish for is a steady increase in the stock’s price or its flatness. Let’s assume the short-term option you sold expired out-of-the-money, so you’ve earned its full premium. Now you have more cash on-hands, and you can sell another short-term call option, and keep doing it over and over again.

# Advanced Poor Man’s Covered Call Strategy to Hedge Big Movements

This strategy will fully hedge your position and is prepared for any market movement, both in the short and the long term. This is a very high maintenance strategy, but if done right can generate consistent returns and is more profitable than Theta gang in the long run.

  • Buy long dated (4 months or later) Call that are ITM.
  • Buy 8-10% OTM Put that expires a month out.
  • Sell a slightly OTM Call at the nearest expiration.
  • Buy a further OTM Call at the nearest expiration (should cost less than 25% of the call you sold).

This way, you are sufficiently protected from all sides. The Calls premium that you sold will become yours and give your Put time to ramp up its Delta. that way, it starts to gain value faster than your Call, thereby protecting from a downward movement. The beautiful thing is that it will consistently outpace your long call, therefore you will always be in a net positive.

Now, remember, this strategy generates money in three ways; either a big upswing or a correction, or if the stock simply remains flat. However, even if it does none of that, you’re still sufficiently protected to limit your losses. Remember the Poor Man’s Covered Call goal is to consistently sell calls and benefit from the premium.

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