Boost Your Income Using Poor Man’s Covered Calls on Dividend Aristocrats

Today I want to discuss how to create a portfolio of Dividend Aristocrats using a poor man’s covered call options strategy.

In a market environment shaped by low rates and low yields in the fixed income arena, Dividend Aristocrats using a poor man’s covered call approach might be an attractive alternative for some investors, especially those seeking steady income.

Briefly, Dividend Aristocrats are a basket of roughly 65 equities that have managed to grow their dividends per share every year for the last 25 years or more. The reason I, among others, like Dividend Aristocrats is because they offer investors some of the safest stocks in the market.

Here is a graphic depicting all the Dividend Aristocrats in the market today:

dividend-aristocrats-poor-mans-covered-calls

Couple Dividend Aristocrats with a poor man’s covered call strategy and you have an incredibly powerful strategy over the long-term. As many of you are already aware, I’ve stated numerous times that one of my favorite options strategies is the poor man’s covered call.

It’s simple, straight-forward and easy to manage. Poor man’s covered calls don’t require buying 100 shares of stock. They allow you to use far less capital, while still receiving the same benefits of a covered call strategy. And the alternative strategy gives you a far greater return on your capital.

In fact, in most cases, it costs 65% to 85% less to use a poor man’s covered call strategy. The savings in capital required should be reason enough to at least consider using the strategy. And I’m certain after reading this you will indeed find the strategy appealing enough to consider.

A Short Background on Poor Man’s Covered Calls

A poor man’s covered call is an inherently bullish strategy that is the same in every way to that of a covered call strategy, with one exception. Rather than spend an inordinate amount of money to purchase at least 100 shares of stock, you have the ability to buy what is essentially a stock replacement. The replacement? An in-the-money LEAPS call contract.

LEAPS, or long-term equity anticipation securities, are options with at least one year left until they are due to expire. The reason we choose to use LEAPS as our stock replacement is because LEAPS don’t suffer from accelerated time decay like shorter-dated options.

My Approach to Poor Man’s Covered Calls Using Dividend Aristocrats

There are numerous ways to approach a poor man’s covered calls options strategy. My preference is to use LEAPS that have at least two years left until expiration.

As for which of the 65 Dividend Aristocrats to choose, I prefer to go with the stalwarts that have high liquidity in the options market and the longest track record of increasing dividends.

Here is a list of the top 10 that I might consider. Ultimately, you must decide what works best for you given a variety of factors, but the list below is certainly a good start.

top-10-dividend-aristocrats

Let’s take a look at Lowe’s (LOW). It’s an expensive stock, yet one of most consistent performers the market offers. However, the cost can be mitigated through the use of a poor man’s covered call. I’ll explain below.

As you can see in the chart below the stock is currently trading for 209.38.

lowes-stock-chart-september-22-2021

If we followed the route of the traditional covered call we would need to buy at least 100 shares of the stock. At the current share price, 100 shares would cost $20,942.

For some investors, the cost of 100 shares can be prohibitive, especially if diversification amongst a basket of stocks is a priority. Therefore, a covered call strategy just isn’t in the cards … and that’s unfortunate.

But with a poor man’s covered call options strategy you can typically save 65% to 85% off the cost of a covered call strategy.

So again, rather than purchase 100 shares or more of stock, we only have to buy one LEAPS call contract for every 100 shares we wish to control.

As I said before, my preference is to buy a LEAPS contract with an expiration date around two years. Some options professionals prefer to only go out 12-16 months, but I prefer the flexibility the two-year LEAPS offers.

The image below shows every expiration cycle available for Lowe’s. Again, I want to go out roughly two years in time. The January 19, 2024 expiration cycle with 849 days left until expiration is the longest dated expiration cycle, but I don’t want to go out that far in time. The June 16, 2023 with 632 days until expiration works for me.

When my LEAPS reach 8-12 months left until expiration I then begin the process of selling my LEAPS and reestablishing a position with approximately two years left until expiration.

lowes-options-expiration-cycles

Once I have chosen my expiration cycle, I then look for an in-the-money call strike with a delta of around 0.80.

When looking at Lowe’s option chain I quickly notice that the 155 call strike has a delta of 0.80. The 155 strike price is currently trading for approximately $62.60. Remember, always use a limit order. Never buy an option at the ask price, which in this case is $63.35.

So, rather than spend $20,942 for 100 shares of LOW, we only need to spend $6,260. As a result, we are saving $14,682, or 70.1%. Now we have the ability to use the capital saved to diversify our premium amongst other securities, if we so choose.

lowes-leaps-poor-mans-covered-calls-dividend-aristocrats

After we purchase our LEAPS call option at the 155 strike, we then begin the process of selling calls against our LEAPS.

My preference is to look for an expiration cycle with around 30-60 days left until expiration and then aim for selling a strike with a delta ranging from 0.20 to 0.40, or a probability of success between  60% to 85%.

As you can see in the options chain below, the 215 call strike with a delta of 0.33 falls within my preferred range.

lowes-short-calls-poor-mans-covered-calls-dividend-aristocrats

We can sell the 215 call option for roughly $2.60.

Our total outlay for the entire position now stands at $6,000 ($62.60-$2.60). The premium collected is 4.2% over 30 days, or 50.4% annually. That’s right, 50.4% annually.

If we were to use a traditional covered call our potential return on capital would be less than half, or 1.2% every 30 days, or 14.4% annually. Plus, the annual dividend of 1.53%.

However, the overall difference in total return is significant between the two approaches: 34.5%.

And remember, the 4.2% is just the premium return; it does not include any increases in the LEAPS contract if the stock pushes higher. Moreover, we can continue to sell calls against our LEAPS position for another 8-12 months, thereby generating additional income or lowering our cost basis even further.

An alternative way to approach a poor man’s covered call, if you are a bit more bullish on the stock, is to buy two LEAPS for every call sold. This way you can benefit from the additional upside past your chosen short strike, yet still participate in the benefits of selling premium.

Regardless of your approach, you can continue to sell calls against your LEAPS as long as you wish. Whether you hold a position for one expiration cycle or 12, poor man’s covered calls give you all the benefits of a covered call for significantly less capital.

Take the time to learn the strategy and, as always, if you have any questions please feel free to email.

 

10 comments on “Boost Your Income Using Poor Man’s Covered Calls on Dividend Aristocrats

  1. Robert Gregor on

    Loved your explanation but I have one question. Do you have a sense if the price of Low would drop say 10 per cent what affect this will have on the Leap? Is this why you choose a leap two years out? And do you sell the legal with 12 months to expiration and start the process again

    Reply
    • Andy Crowder on

      Robert,

      Thanks for the kind words and the question. It is an important one and one that should not be ignored. I’ve written a few articles on risk-management and will be doing a few videos as well in the near future. As always, position-size is the most important aspect, followed by a strict guideline to stop loss. fF course, each individual with have their own level of not only position-size , but stop-loss as well, but there needs to be a concerted effort to both. I sounds easy, but emotions can takeover when losses start to occur, so have a plan in place prior to make each and every trade. I keep selling against my LEAPS position every 30-45 on average which lowers my overall cost basis. I also have the ability to collar my position as well. Regardless, of whether we are using a PMCC or PMCP we always pay attention to the delta. If the delta of the LEAPS contract pushes below 0.50, it is time to roll the position to another strike with a higher delta. I hope this helps.

      Reply
  2. Mohan on

    Interesting article. How would you handle these 2 scenarios?
    1) Let’s say LOW goes to $240. Would you close out of your position completely?
    2) Let’s say LOW goes to $180. Would you buy more LEAPs?

    What if you add the same strategy on the PUT side as well? What are your thoughts on that?

    Reply
    • Andy Crowder on

      Thanks Mohan! I’ve written a few articles on risk-management and will be doing a few videos as well in the near future. As always, position-size is the most important aspect, followed by a strict guideline to stop loss. fF course, each individual with have their own level of not only position-size , but stop-loss as well, but there needs to be a concerted effort to both. I sounds easy, but emotions can takeover when losses start to occur, so have a plan in place prior to make each and every trade. I keep selling against my LEAPS position every 30-45 on average which lowers my overall cost basis. I also have the ability to collar my position as well. Regardless, of whether we are using a PMCC or PMCP we always pay attention to the delta. If the delta of the LEAPS contract pushes below 0.50, it is time to roll the position to another strike with a higher delta. I hope this helps.

      Reply
  3. Naveen on

    A very nice strategy. I have question, what happens when stock turns bullish and keeps going up and up till your short call and option expiry date. Your short dated short call would go up in value and also long dated deep ITM long call.

    Now, to close your short call, you have to either spend more money or roll it to another expiry and that also cause a realized loss. If your short call becomes very near ITM, will you be rolling it to another expiry? Won’t it be causing loss instead of gain?

    Reply
    • Andy Crowder on

      We simply buy back our short call prior to expiration if our short call is deep in-the-money or the delta of our short call has moved in parity with our LEAPS contract. The stock moving higher is the best case scenario for a poor man’s covered call position, as it is a delta positive position at the onset of the trade and continues to be until the delta of the short call equals that of the LEAPS position. At that point, most of the time prior, we simply buy back our short call and sell more premium or simply take the entire position off for a nice profit. Also, remember, the cost of using a poor man’s covered call is significantly less than that of a covered call. This enables you to diversify amongst a basket of stocks and create significantly more premium. I hope this helps.

      Reply
    • Andy Crowder on

      Chris,

      Thanks for the question. If we are selling calls every 30 days we should be able to sell premium on at least 12 occasions, thereby leading to upwards of 50.4% in premium sold on an annual basis. Remember, this is just premium sold. I hope this helps.

      Reply
    • Andy Crowder on

      William,

      Thanks for the question. We buy it back and sell more premium (if we choose to continue selling premium) going out roughly 20 to 60 days in duration. We manage the position appropriately to avoid this type of situation and accelerated gamma risk. Hope this helps.

      Reply

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