Poor Man’s Covered Call

The Poor Man’s Covered Call (PMCC) is a versatile options trading strategy that allows investors to generate income with less capital than a traditional covered call. This strategy is particularly beneficial for those who want to leverage the potential of covered calls but do not have enough capital to purchase a large number of shares outright. By using options instead of owning the underlying stock, traders can mimic the benefits of a covered call while requiring significantly less capital.

Understanding the Poor Man’s Covered Call

At its core, the Poor Man’s Covered Call involves buying a long-term call option (also known as a LEAPS, which stands for Long-term Equity AnticiPation Securities) and selling a short-term call option against it. This creates a diagonal spread, as the long call and short call have different expiration dates and, typically, different strike prices.

1. Buying the LEAPS Call Option:
   • The first step is to purchase a deep-in-the-money LEAPS call option, which acts as a substitute for owning the actual stock. This long-term option generally has an expiration date of one to two years in the future. By choosing a deep-in-the-money option, the trader ensures that the option behaves more like the underlying stock, with a high delta (meaning it will move similarly to the stock price).
2. Selling the Short-term Call Option:
   • The next step is to sell a short-term call option, typically one to two months out, against the long-term LEAPS call. This short call generates premium income, similar to the income generated in a traditional covered call strategy. The premium collected from selling the short call helps offset the cost of purchasing the LEAPS call.

Advantages of the Poor Man’s Covered Call

1. Lower Capital Requirement:
   • One of the main advantages of the PMCC is the significantly lower capital requirement compared to a traditional covered call. Instead of buying 100 shares of a stock, which can be quite expensive, the trader only needs to purchase a LEAPS call option, which requires much less capital.
2. Leverage:
   • The PMCC strategy allows traders to leverage their positions. Since options can control a larger number of shares for a fraction of the cost, traders can potentially achieve higher returns on their invested capital.
3. Income Generation:
   • Like the traditional covered call, the PMCC generates income through the premium received from selling the short-term call options. This income can provide a steady cash flow, which is particularly attractive in a sideways or moderately bullish market.
4. Limited Downside Risk:
   • The maximum risk in a PMCC is limited to the cost of the LEAPS call option. Unlike owning the actual stock, where the loss can be substantial if the stock price plummets, the risk in a PMCC is confined to the premium paid for the long-term call option.

Considerations and Risks

While the PMCC has many advantages, it is not without risks and considerations:

1. Time Decay (Theta):
   • The value of the LEAPS call option will decay over time. While the short-term call option sold will also decay, the net effect of time decay can impact the overall profitability of the strategy.
2. Volatility (Vega):
   • Changes in implied volatility can affect the value of both the LEAPS call and the short-term call options. A significant drop in volatility can reduce the value of the long-term call option, negatively impacting the position.
3. Stock Movement:
   • If the stock price rises significantly, the short-term call option sold might be exercised, capping the potential upside. Conversely, if the stock price falls significantly, the LEAPS call option might lose value, and the trader could incur a loss.

Conclusion

The Poor Man’s Covered Call is a powerful strategy for generating income with a lower capital requirement. By using long-term LEAPS calls and selling short-term calls against them, traders can mimic the benefits of a traditional covered call while leveraging their investment and managing risk. However, like any options strategy, it requires careful monitoring and an understanding of the risks involved. When executed correctly, the PMCC can be a valuable addition to a trader’s toolkit, providing a steady income stream and capital appreciation potential.