How to Build an All-Weather Portfolio Using a Poor Man’s Covered Call Strategy

poor-mans-covered-call-strategy-SPY

Over the past two weeks I’ve discussed several of the income strategies I like to use in my overall portfolio; covered calls and poor man’s covered calls.

Today, I want to focus on how to build out a portfolio using a poor man’s covered call strategy.

Now I tend to take a diversified portfolio strategy approach. And by using poor man’s covered calls I can diversify my strategies of choice far easier. For instance, I might use poor man’s covered calls on an All-Weather portfolio, Dogs of the Dow portfolio, Growth/Value portfolio, Contrarian portfolio, Earnings Yield portfolio and several others.

The one stalwart is the All-Weather portfolio, which is what I’m going to focus on today.

The All-Weather portfolio is a portfolio that is available to the masses. All investors have access to some form of the risk-parity-based All-Weather Fund that was created by legendary hedge fund manager Ray Dalio.

The portfolio is designed to survive all different types of market environments.

Here is a breakdown of asset allocation:

  • 40% long-term Treasuries
  • 20% U.S. stocks
  • 10% International
  • 15% intermediate-term Treasuries
  • 5% commodities, diversified
  • 5% gold

Next, I want to find a few ETFs that work. The selection is harder than you think because we have a few more requirements than just buying the ETF outright. We need to think about an ETF that:

  1. Falls into one of the asset classes above.
  2. Has liquid options.
  3. Offers LEAPS that have roughly 2 years until expiration.

Thankfully, there are choices, but I wouldn’t say they are plentiful. Liquid options markets can be tough in certain asset classes. As a result, I have no choice but to alter my allocation to differ ever so slightly from Dalio’s allocation.

Here is the allocation I use:

  • iShares 20+ Year Treasury Bond ETF (TLT)
  • SPDR S&P 500 ETF (SPY)
  • iShares MSCI EAFE ETF (EFA)
  • SPDR Gold Shares ETF (GLD)

The four ETFs above allow me the opportunity to buy LEAPS that have at least 2 years in duration. Again, the goal is to buy a LEAPS as far as possible and continue to sell short-term calls against my LEAPS contracts. Once my LEAPS have roughly 8 to 12 months of life left, I then begin the process of rolling my LEAPS contract out as far as I can and continue the process of selling more premium.

Historically, I have been able to outperform major market indices by 3 to 5 times using a poor man’s covered call approach while simultaneously limiting my downside risk.

Here is an example of how I would initiate a position.

SPDR S&P 500 ETF (SPY)

The S&P 500 ETF (SPY) is currently trading for 447.97.

stock-chart-SPY-August-24-2021

I choose my LEAPS call contract by the delta of the option. I prefer to initiate a LEAPS position by looking for a delta of 0.80. With a delta of 0.78, the December 15, 2023 355 call strike with 842 days until expiration works.

poor-mans-covered-call-LEAPS-SPY

I can buy one options contract, which is equivalent to 100 shares of SPY, for roughly $110.00, if not slightly cheaper. Remember, always use a limit order, never buy at the ask price, which in this case is $112.50.

If we buy the 355 strike call for roughly $110.00, we are out $11,100, rather than the $44,797 I would spend for 100 shares of SPY. That’s a savings on capital required of 75.2%. Now we can use the capital saved ($33,697) to work in other ways, preferably to diversify our poor man’s covered call strategy among other stocks and ETFs.

Once we make the initial LEAPS purchase, we can maintain that position and focus on selling near-term call premium against our LEAPS each month – thereby generating income and lowering the original cost basis with each transaction.

I begin the process of selling shorter-term calls against my LEAPS, by looking 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 455 strike call with a delta of 0.28 falls within my preferred range.

poor-mans-covered-calls-short-calls-SPY

I can sell the 455 call for roughly $2.12.

My total outlay for the entire position now stands at $107.88. or $10,788 ($110.00 – $2.12). The premium collected is 1.9% over 30 days. Not a ton of premium, but remember, we are going out 30 days and using an ETF that has, by most comparisons a low level of implied volatility (IV).

But remember, if we were to use a traditional covered call our capital outlay would be $44,797 and our return would be 0.5%.

Also, the 1.9%, or 22.8% annually, is just the premium return, it does not include any increases in the LEAPS contract if the stock pushes higher. Since our initial delta is 0.50 (0.78 – 0.28), the LEAPS contract will increase by $0.50 for every dollar SPY moves higher.

The overall delta of the position will eventually hit a neutral state if SPY continues to move higher over the next 30 days. If it does, we simply buy back our short call and sell more premium.

Delta is a major factor in managing poor man’s covered calls. I’m going to start going over the Greeks, including delta, theta and gamma next week. Stay tuned!

So, as you can see above, we have the potential to create 1.9% every 30 days, or approximately 22.8% a year using a fairly conservative ETF like SPY. This is our baseline and should be our expected return in premium, but again this does not include any capital gains from our LEAPS position if SPY trends higher.

My next steps would be to add a position in TLT, EFA and GLD using the guidelines mentioned in my SPY example above.

As always, if you have any questions, please feel free to email me or post in the comments section below. And if you haven’t had a chance, please sign up for my free weekly newsletter where I offer options education, research, and trade ideas.

 

10 comments on “How to Build an All-Weather Portfolio Using a Poor Man’s Covered Call Strategy

    • Andy Crowder on

      We are going out 2-years in time and rolling when there is 8-12 months left, so there isn’t concern. Remember, we are long LEAPS calls with typically 2+ years at the onset and sell short-term calls (20-60 days) against out long position (LEAPS). Hope this helps.

      Reply
    • Andy Crowder on

      Thanks for the question Bob. I typically buy back the short call, when there is little to no value left in the short call. Or, if the price of the underlying security pushes past the short call strike, I start to look at the overall delta on the position. If we see the delta of the short call move closer to parity with the delta of the LEAPS contract(s) I will then buy back the short call and sell another call or simply take off the position for a nice profit.Remember, we start out with a delta of roughly 0.80 for our LEAPS and a delta of 0.30 for our short calls. As the stock moves higher we are making significantly more on our LEAPS contract than losing on our short call. So, even if the price moves past our short call we are still making money on the position, that is, until the delta on both the LEAPS and our short calls are at parity. I hope this helps clear up a few things for you.

      Reply
      • Steve on

        Thanks, Andy-I love this strategy! I can buy 3 SPY or TLT or GLD LEAPS for the price of 100 shares and write three covered calls instead of one. EFA seems to move in concert with SPY and does not seem uncorrelated, but the other three do. The wide bid ask spread on the LEAPS seems to be the major downfall. Do you modify the strategy if one of the assets is in a clear down trend like TLT is right now? Please start a YouTube channel!

        Reply
  1. Maurice Derrick on

    If the stock price exceeds the short call of $455 prior to the 30 DTE and the short call is called away (i.e. the new stock price is now $465), can you explain the trading mechanics of the short call, leap and provide the profit/loss calculations. Do you buy back the short call at $465 for a loss, and what do you do with the leap? I understand the trading mechanics with the traditional Covered Call, but confused when using a LEAP!!!

    Reply
    • Andy Crowder on

      Thanks for the question Maurice. I typically buy back the short call, when there is little to no value left in the short call. Or, if the price of the underlying security pushes past the short call strike, I start to look at the overall delta on the position. If we see the delta of the short call move closer to parity with the delta of the LEAPS contract(s) I will then buy back the short call and sell another call or simply take off the position for a nice profit. I’ll be posting a video shortly that goes over numerous examples of my approach to poor man’s covered calls. Stay tuned!

      Reply
  2. Steve on

    Great strategy, Andy-thanks! For someone who can afford to buy at least 1 contract of all of the ETFs you mention above, do you recommend a traditional covered call approach or do you still prefer trading poor man’s covered calls? I signed up for your newsletter but never received it. Where do you post your videos? I used to love your Wyatt research videos on YouTube and am disappointed that they have been deleted.

    Reply
    • Andy Crowder on

      Steve, thanks for the kind words. Check your spam/junk folder, as sometimes it is located there. Once you give it approval you should start receiving the free newsletter in your inbox. As for which to use, it is really up to you to decide which is best. It just depends on how much capital you wish to allocate and that’s definitely a personal decision. Thanks again.

      Reply
    • Andy Crowder on

      Also, I forgot to mention, videos are coming soon…most likely next week. I will be including them in the weekly newsletter as well. Stay tuned!

      Reply

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