Poor Man’s Covered Call

What on Earth is the Poor Man’s Covered Call?

The poor man’s covered call is a variation of the traditional covered call options strategy, only instead of purchasing the underlying stock as the covering asset, you buy long dated call options instead.

Long dated call options are often referred to as LEAPS options. These are options contracts with an expiration date of at least one year away. As such, the “time decay” component on these contracts will be minimal in the early stages of the contract, so that they effectively serve the same purpose as if you had purchased the underlying stock itself.

Poor Man’s Covered Call Example

You believe that a company’s share price will either rise or remain reasonably steady over the next month. Now if you were covered calls trader with a large enough bank account, you would normally purchase multiples of 100 shares of a given company, then sell call options on these shares.

But here’s what you do instead.

For our example, let’s imagine you are thinking in terms of 500 shares, currently trading at $20 per share.

You buy 5 deep-in-the-money LEAPS call options contracts on an underlying asset such as company stocks or an ETF. By “deep in the money” we mean, with a strike price which is at least 10 percent lower than the current trading price of the stock and with an options delta of at least 0.85.

Then you sell call options on the same underlying asset with next month’s expiration date. You can sell these call options at any strike price above the strike price of the LEAPS options. It all depends on which covered call writing strategy you have chosen.

The sold short dated call options, for which you receive a credit to your account, are covered by the LEAPS options you have purchased.

Now if you had purchased the actual shares in this company, it would’ve cost you 500 x $20 = $10,000.

But the deep in the money LEAPS call options would only cost you about one-tenth of this amount. So instead of risking $10k on the underlying asset, you have only risked about $1,000. Can you see now, why it is called a “poor man’s covered call”? It allows you to realize all the benefits of regular covered calls, but at only a fraction of the cost.

This leaves you with more capital which with to apply your chosen covered call strategy on other trades. You can choose to hold your long dated LEAPS options as if they were the actual shares themselves and sell short dated call options over them, month after month, if you like. It will all depend on what is happening with the underlying asset itself. You need to take notice of this because you may wish to make adjustments to the positions, if necessary.

The important thing to bear in mind though, is that unlike real company shares, your LEAPS options will eventually expire. When this happens, they will either be “in the money” and have some real value, or “out of the money” and be worthless. Knowing this should affect your decision on how long to hold them for, while you continue you sell your short dated call options on them.

The poor man’s covered call is a great alternative to traditional covered call investing. For more in depth reading on covered calls, refer to our covered calls main page and navigate from there.

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