Are you looking for a way to increase your profits from stock options? If so, then you should consider using Poor Man’s Covered Calls. This strategy is simple to understand and easy to implement, and it can help you maximize your profits from stock options. In this guide, we will teach you everything you need to know about Poor Man’s Covered Calls. We will discuss:
What is a Poor Man’s Covered Call?
What is the best time to put on a Poor Man’s Covered Call?
How do we set up a Poor Man’s Covered Call (Real Trade Example)?
Max Profit and Loss for a Poor Man’s Covered Call
Benefits of a Poor Man’s Covered Call and why use a PMCC?
Poor Man’s Covered Call versus regular Covered Call
Managing the PMCC
So let’s get right into it!
What is a Poor Man’s Covered Call?
A Poor Man’s Covered Call is an option trading strategy that is used to generate income from stock holdings. The Poor Man’s Covered Call involves buying a long-term deep-in-the-money call (also known as LEAPS) option and selling a near-term out-of-the-money call option on a stock that the investor already owns. The goal of this strategy is to receive the premium from selling the call option, while still owning the replicated stock as it increases in value.
What is the best time to put on a Poor Man’s Covered Call?
The best time to implement a Poor Man’s Covered Call is when the stock price is expected to remain relatively flat or move slightly higher over the near and long term. In other words when you are neutral to bullish on a stock. This strategy works best in markets that are experiencing mid to high levels of volatility.
A good market to put on PMCC’s is when stocks have been beaten down and good quality stocks are available at a discount. If they have already been killed then you can look to pick up the best in class stocks in different sectors and utilize PMCC’s.
How do we set up a Poor Man’s Covered Call (Real Trade Example)?
We will show you a real example of a PMCC in FB. We will use the TastyWorks Trading Platform to put this trade on. This is the platform that I like the most for stock option trading due to its simplicity, intuitiveness and low-cost trades. Use the link below, open an account with $2000 and pick up $200 in free stock.
So we punch in FB and go to the trade tab. I like to look out more than 1 year. The Sept 2023, 25 delta option is the 160 strike and the cost is 59.25 or $5925. We place the trade to buy that deep-in-the-money option.
Then we will sell the OTM out-of-the-money 25 delta Call in the 45-60 day range. So we go to the July option tab and sell the 220 strike Call and collect $3.75 or $375.
Now our cost is $5,485 since it is the $5925 we paid to buy the $160 Call minus the $375 we collected from selling the 220 strike-near term Call.
Max Profit and Loss for a Poor Man’s Covered Call
The maximum profit and loss for the Poor Man’s Covered Call is a little tricky. This is because we are placing trades in different months with different options.
However, the max loss is going to be the price we pay for the long deep-in-the-money call minus the premium we collect from the near-term call that we sell. So in this case it will be the $5485 cost paid upfront. This loss would occur only if the stock went to zero and the company filed BK. We will not put this trade on with stocks that are in risky cash and debt positions or at risk of going BK.
The max profit can be calculated in the short term only. It is the width of the call strikes minus the entry cost. So in this case it is the 220-160 which is $60 or $6000 minus the 5480 paid upfront. So it is $520.
We receive this if the stock moves anywhere above the 220 near-term call at the expiration date of the near-term call. We will profit from the rise in the price of the long deep-in-the-money call that we bought.
However, at the same time, we have capped our gains because the near-term call that we sold. By doing this we will allow someone else to buy the stock away from us at that 220 strike price.
Benefits of a Poor Man’s Covered Call and why use a PMCC?
The Poor Man’s Covered Call is a great way to generate income from stocks that you want to own. Or replicate owning with the LEAPS and are bullish on. The PMCC offers some limited downside protection while still allowing the investor to participate in upside potential.
One can continue to sell near-term calls and continue to collect option premium against the long position over time. You will only want to do this if you are still bullish on the trade. As well as the long-term prospects for the stock. Sometimes we think a stock moves too high and no longer think it is undervalued. So we can just close the position. Then move on to a different trade.
The greatest benefit, in my opinion, is that you can control stock while using much less buying power than if you were to own the stock outright. So this gets into the differences between the PMCC and the regular Covered Call.
Poor Man’s Covered Call versus regular Covered Call
Much less BPR (Buying Power Reduction) is required with a PMCC because the max loss is the price you paid for the deep-in-the-money call minus the premium collected from the near-term call that you sold.
This is opposed to the full price that you would pay if you owned the stock outright as done with a regular covered call. The cost paid upfront with the deep-in-the-money call to control the 100 shares of stock in 1 contract was only $5925.
The cost to own 100 shares of stock outright with the price at $193.54 is $19,354. So it is about 1/3 the cost using the PMCC strategy.
The profits received from the PMCC are slightly less than the regular covered call. However, the tradeoff is that the risk is slightly less as well since the .
Managing the Poor Man’s Covered Call
The PMCC is pretty easy to manage. There are two legs in different months in the PMCC with the long deep-in-the-money call and then the near-term OTM call. So the easiest way is to look at each of them individually.
Many like to put on the long deep-in-the-money call with around 120 days to expiration to replicate long stock. However, I like to go much longer out in time for a couple of reasons. First, the cost to go out over 1 year is not much more as a percentage than just going out 120 days. Going out further in time it allows more time for the stock to move up in price and you don’t have to adjust this leg.
So I like to keep the LEAPs out over 1 year in time. When it gets close to 1 year DTE (days to expiration) it doesn’t cost much at all to sell to close and buy again out over 1 year. So as long as I am bullish on the stock, I keep doing this every few months with the long call side of the PMCC.
On the near-term short OTM call, I manage it just like I would any other short call option. At 21 DTE (days to expiration) I will look to roll to the next month and collect more premium. I like to adjust to around the 20 or 25 delta strike price at that time.
If the price of the stock moves above the short call strike at any time, I look to close out the entire PMCC trade if I no longer think the stock is undervalued. Sometimes I still want to own the long deep-in-the-money call and believe the stock will continue up. In this case, I will just buy back and close out the short call and readjust it by moving it up and out.
Conclusion
The Poor Man’s Covered Call is a great way to generate income from stocks that you are bullish on. This strategy is great in markets where high quality stocks have been beaten down are a great value. The PMCC offers limited downside protection while still allowing the investor to participate in upside potential. The trade is easy to manage and the amount of buying power required is much less than if you were to own the stock outright and sell a covered call each month.
Always do your research and consider your investment goals before you begin trading stock options. For more stock and financial information, please check out our other resources at Darrensteves.com and OptionsFinanceProfits.com.
I hope you enjoyed this tutorial on Poor Man’s Covered Calls. Let me know if you are using PMCC’s and which stocks you are using today. If you have any questions or comments, please leave them in the comment section below.
Happy trading!