What is a Poor Man’s Covered Call?
The poor man’s covered call (PMCC) is a bullish options strategy that is similar to a covered call without needing 100 shares. This is a perfect strategy for trading a small portfolio. A poor man’s covered call is an alternative to the covered call strategy in many ways. It has a similar return and risk profile as the covered call.
The PMCC strategy allows for in many cases 10% of what buying 100 shares would cost in collateral.
The PMCC reduces the capital/margin requirement of a traditional covered call by replacing the long stock with an in-the-money call option. The in-the-money call option is referred to as a LEAP if it’s longer than a year to expiration.
LEAP options are typically available for a variety of underlying assets, such as stocks, indexes, and exchange-traded funds (ETFs). Like other options contracts, a LEAP gives the holder the right, but not the obligation, to buy or sell the underlying asset at a predetermined price (known as the strike price) on or before the expiration date. It’s basically a call that’s way out in the future. LEAP options can be attractive to investors who are looking to gain exposure to an underlying asset over a longer time horizon, as the longer expiration date allows for greater flexibility in how long an investor holds the option.
How to Set Up a Poor Man’s Covered Call Basics
- Buy a deep in-the-money call option in a long-term expiration cycle (typically 12 months but can be 6 months)
- Sell an out-of-the-money call option using your LEAP call options as the 100 shares replacement
- Potentially buy back the call to avoid poor man’s covered call assignment
How to Set Up a Poor Man’s Covered Call in Robinhood
As you can see below, here is a SBUX poor man’s covered call example.
Buying a $100 call option for 6/21/2024 expiration (This is our LEAP) Selling a $110 call option for 6/16/2023 expiration (This is our short call to collect premium)
If you don’t have Robinhood you can always get free stocks as they give Invest with Henry a special link.
Managing A Poor Man’s Covered Call Assignment Risk
Managing and closing the risk associated with a poor man’s covered call assignment requires careful attention to market conditions and an understanding of options trading strategies. The poor man’s covered call is more complicated than just a regular covered call as the LEAP option that serves as 100 shares is similar to 100 shares but not identical. Here are some ways to manage and close risk associated with this strategy:
- Adjust the Strike Price: One way to manage risk in a poor man’s covered call assignment is to adjust the strike price of the short-term call options as the market moves. If the underlying asset price increases significantly, the investor may want to consider raising the strike price to capture more profit. If the price declines, the strike price can be lowered to minimize potential losses.
- Roll the Short-Term Call Options: Rolling the short-term call options involves closing out the current position and simultaneously opening a new position with later expiration dates and/or different strike prices. This can help manage risk by extending the time horizon or adjusting the strike price of the options.
- Close Out the Position: If the underlying asset price moves in an unfavorable direction, the investor may choose to close out the position entirely. This involves selling the LEAP and buying back the short-term call options, effectively ending the poor man’s covered call assignment. While this may result in a loss, it can be a way to limit potential losses and free up capital for other investments.
- Use Stop-Loss Orders: A stop-loss order is an order to sell the LEAP or buy back the short-term call options if the underlying asset price reaches a specified level. This can be a useful tool for managing risk and limiting losses if the market moves in an unfavorable direction.
I don’t love stop-loss orders but with a poor man’s covered call having this measure can be wise.
Closing A Poor Man’s Covered Call
Here’s some ways to close a poor man’s covered call.
- Buy Back the Short-Term Call Option If the underlying stock price moves up and the short-term call option you sold becomes in-the-money, you may want to buy back the call option to avoid being assigned. This can be done by placing a buy-to-close order with your broker. When you buy back the short-term call option, you will be able to keep your LEAP call option and collect the premium from the sale of the short-term call option. This will allow you to continue to benefit from the bullish trend of the underlying asset.
- Close Out the Entire Position If you want to close out the entire position, you can sell your LEAP call option and buy back the short-term call option. This will effectively end the PMCC assignment and allow you to free up your capital for other investments. Keep in mind that closing out the entire position may result in a loss, especially if the underlying asset price has moved in an unfavorable direction. However, this may be a way to limit potential losses and exit the position with a smaller loss.
- Roll the Short-Term Call Option Rolling the short-term call option involves closing out the current position and simultaneously opening a new position with later expiration dates and/or different strike prices. This can help manage risk by extending the time horizon or adjusting the strike price of the options. Rolling the short-term call option can be a useful strategy if you still believe the underlying asset will continue to be bullish. This can also allow you to collect additional premium by selling another call option.
How to Pick Stocks For A Poor Man’s Covered Call
First of all, let’s about the most important thing in profitably trading the PMCC strategy – volume. The volume of options being traded is a crucial factor to consider when implementing the poor man’s covered call strategy. Volume represents the number of contracts that have been traded for a particular option and is an important indicator of the option’s liquidity.
Options with high volume are preferred for this strategy as they indicate a larger pool of buyers and sellers, making it easier to enter or exit a position without impacting the price too much. In contrast, low volume options are less liquid and may be difficult to buy or sell at the desired price.
Moreover, low volume options often have wider bid-ask spreads, which can increase trading costs. Additionally, they may be more susceptible to price manipulation by large traders due to their lower trading activity.
Hence, when implementing the poor man’s covered call strategy, it is recommended to prioritize options with high volume, as they provide greater liquidity, tighter bid-ask spreads, and less susceptibility to price manipulation.
Now that we have covered the importance of volume in the poor man’s covered call strategy, let’s discuss how to pick stocks for this strategy. When selecting stocks for the poor man’s covered call strategy, it’s important to consider a few key factors:
- Volatility: Stocks with moderate volatility are generally preferred, as they offer the potential for price appreciation without excessive risk. High volatility stocks may offer larger potential returns but also come with higher risk, while low volatility stocks may offer lower returns and may not be suitable for this strategy.
- Liquidity: Stocks with high trading volume are preferred, as they offer greater liquidity, which can help minimize trading costs and reduce the risk of price manipulation.
- Dividend yield: Stocks with a moderate to high dividend yield can help increase the income generated from the strategy, which is the main objective of the poor man’s covered call strategy.
- Fundamental analysis: Consider the company’s financial health, growth prospects, and competitive landscape. It’s important to select stocks with strong fundamentals, as they are more likely to offer stable returns and less downside risk.As someone who has worked for Goldman Sachs and scaled my options portfolio to $2,000,000, I can say that I heavily focus on high quality stocks with good fundamentals when implementing the poor man’s covered call strategy. Having worked in the financial industry for a significant period of time, I have learned the importance of fundamentals in selecting stocks for any investment strategy. With the poor man’s covered call strategy, it’s crucial to select stocks with a stable financial background and growth potential to maximize returns and minimize risk.
By selecting the right stocks for the poor man’s covered call strategy, I have been able to generate significant returns while minimizing risk. This strategy along with the wheel strategy has allowed me to grow my options portfolio to $2,000,000. I’ve also relied heavily on Spreads. In fact I think spreads are the key to growing a small option trading account. That’s why the best video I have on my channel is titled – Spread Trading: Ultimate Steady Guide To Grow A Small Option Portfolio.
