The Poor Man's Covered Call
Selling a Covered Call is the one Safest Trades in the Market
A covered call is a trading strategy where an investor holds a long position in an asset (such as stocks) and sells call options on that same asset to generate additional income.
The goal of this strategy is to earn income through option premiums while also potentially participating in any upside movement in the underlying asset's price.
This strategy is considered a great trading strategy because it allows the investor to earn passive income in a flat or slightly bullish market, and also provides some downside protection for the long position in the underlying asset.
Additionally, covered calls can help manage risk by establishing a maximum potential loss for the long position and providing the investor with a pre-determined exit point if the underlying asset's price exceeds the strike price of the call option.
We are a Covered Call fund, meaning we are generating monthly income by selling Covered Calls against our long positions, and we are always long.
Additionally we also run an alternative to a Covered Call, it's referred to as a Poor Man's Covered Call.
Covered Call is one of the easiest strategies to implement, but the problem, at least for some, comes down to capital. You must have at least 100 shares of stock to sell a call. For some, acquiring 100 shares just isn’t affordable. Others prefer not to tie up working capital toward 100 or more shares of stock.
A poor man’s covered call is similar to a traditional covered call strategy, with one exception in the mechanics. Rather than buying 100 or more shares of stock, an investor simply buys an in-the-money LEAPS call and sells a near-term out-of-the-money call against it.
LEAPS, or long-term equity anticipation securities, are basically options contracts with an expiration date longer than one year. LEAPS are no different than short-term options, but the longer duration offered through a LEAPS contract gives an investor the opportunity for long-term exposure.
Other than reducing the capital required, the reason we purchase LEAPS is to minimize the extrinsic value and theta decay. Basically, a poor man’s covered call is viewed as a diagonal trade with a significantly longer duration.
First of all, I always start – just like when I use a traditional covered call strategy – by choosing a low-beta stock. I want a stock with low volatility because the strategy works best when there is minimal vacillation in the underlying stock.
Take for instance PROCTER & GAMBLE CO (PG). The stock has experienced a recent pullback, which could offer a nice entry point for a poor man’s covered call.
The stock exemplifies the typical low-beta, blue chip stock that I look for when using a poor man’s covered call strategy.
The next step is to choose an appropriate LEAPS contract to replace buying 100 shares of PG stock. If we were to buy PG stock at $142.61 per share, our capital requirement would be a minimum of $14,261 plus commissions ($142.61 times 100 shares).
If we look at PG’s option chain, we will quickly notice that the expiration cycle with the longest duration is the January 2025 cycle, which has roughly 700 days left until expiration.
With the stock trading at $142.61 I prefer to buy a contract that is in the money at least 10%, if not more. I used the $135 strike price for this trade.
We can buy one options contract, which is equivalent to 100 shares of PG stock, for roughly $21.90, if not cheaper. Remember, always use a limit order – never buy at the ask price, which in this case is $22.65.
If we buy the $135 strike for $21.90 we are out $2,190 ($21.90 x 100 shares), rather than the $14,261 ($142.61 x 100 shares) we would spend for 100 shares of PG. That’s a savings on capital required of ~85%. Now we have the ability to use the capital saved ($12,071) to work in other ways.
The next step is to sell an out-of-the-money call against our LEAPS contract. aka Covered Call.
Our strategy is selling monthly Covered Call, we like generating monthly income, it is now February 4th 2023, so I look out to the March expiration which is 41 days left until option expiration.
With the stock trading at $142.61 I choose the 150 strike price for my Covered Call. Why did I do that, good question, the Delta is 18% which means there is a 82% probability that our trade will be successful. We only take 80% or greater probability of success on any of our trades.
This is Blackjack in Las Vegas and we are not gambling, using Options and the safest trading strategy in the market (covered calls) we generate monthly income for our members...enough said
Let's do the math, Selling a Covered Call on 1 options contract at 150 strike price, which will pay us $.71 cents per share (midpoint between the bid and the ask) would generate $71 in steady income for that month. We generally buy 2,000 contract, which would generate $142,000 in monthly income for our members. (2,000 x 100 x $.71cents).
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