How to Use Poor Man’s Covered Calls on Lower-Priced Stocks

poor-mans-covered-calls

Poor Man’s Covered Calls 

A few months ago I discussed the benefits of selling covered calls for monthly income. And while I am a huge proponent of using covered calls, my preference, particularly when dealing with higher-priced securities, is to use a strategy known as the poor man’s covered call strategy.

A poor man’s covered call strategy is essentially a long call diagonal debit spread that is used to imitate a covered call position, but for far less capital.

The main difference: poor man’s covered calls require far less capital. The strategy doesn’t require buying 100 shares of stock. In fact, no shares are needed. As an alternative to purchasing 100 shares, poor man’s covered calls require far less capital.

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.

Like a covered call strategy, a poor man’s covered call is an inherently bullish options strategy. But again, 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.

Today, I’m going to focus on selling poor man’s covered calls on lower priced stocks for monthly income.

The key is to screen stocks that have highly liquid options and a mid-to-high level of implied volatility.

Now I’m not going to get too picky here on stock selection as I am more concerned about teaching the concept of using a poor man’s covered call on a lower-priced stock. So, try not to get too fixated on my stock of choice.

And hey, if you think the stock I’m about to use for my example is about to crater, you can always use a poor man’s covered put, which I have discussed numerous times over the past few months.

Poor Man’s Covered Call

Oatly (OTLY) is currently trading for 14.62 and has an implied volatility (IV) just over 80%. Moreover, the stock has a beta of 0.48.

After a successful IPO launch that saw the stock push notably higher for a few weeks, the stock has suffered mightily since the middle of June, essentially cutting the stock value in half. Just remember, I take a statistical approach to the market, so what I’m about to show you, from a statistical standpoint, looks like a decent trading opportunity.

stock-chart-OTLY-october-20-21

When looking at Oatly’s option chain I quickly noticed that the 10 call strike has a delta of 0.81. The 10 call strike price is currently trading for approximately $6.60. Remember, always use a limit order. Never buy an option at the ask price, which in this case is $6.70.

poor-mans-covered-calls-leaps-oatly

So, rather than spend $1,462 for 100 shares of Oatly, we only need to spend $660. As a result, we are saving $802, or 54.9%. Now we have the ability to use the capital saved to diversify our premium or income stream amongst other securities, if we so choose.

After we purchase our LEAPS call option at the 10 call 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%. However, with lower priced stocks we often have to use a delta closer to 0.50 in order to bring in an acceptable level of premium.

As you can see in the options chain below, the 15 call strike with a delta of 0.50 falls within my preferred range. And the probability of success stands at 58.85%.

poor-mans-covered-calls-november-options-chain-oatly

We can sell the 15 call option for roughly $1.05.

Our total outlay for the entire position now stands at $555 ($660 – $105). The premium collected is 15.9% over 30 days.

But, if we were to use a traditional covered call our potential return on capital would be less than half, or 7.2% over 30 days.

Poor Man’s Covered Call Trade:

  • Buy Oatly (OTLY) January 20, 2023 10 LEAPS call contract for roughly $6.60
  • Sell Oatly (OTLY) November 15 calls (30 days until expiration) for $1.05, or $105 per contract

Static or Return on Premium: 15.9% over 30 days

Breakeven: $5.55, or $555

So, as you can see above, all things being equal, we have the potential to create roughly 15% every 30 days, or an astounding 180% a year using a Oatly as our underlying stock of choice.

Realistically, we are probably aren’t going to bring in 180% on an annual basis, but certainly we have the potential and more importantly, you can see the power of using poor man’s covered calls.

I also want to add that if OTLY pushes above 15 we still have the ability to make capital gains on our LEAPS contract, thereby increasing our overall return. Inherently the overall position is long deltas (0.80 – 0.50 = 0.30) so it would take a move that pushed the delta of the short call (0.50) at parity with the long call (0.80). Unlike a covered call the gains are not capped by the short call. The gains are capped when both the long call and short call have a delta that is the same. When this does occur, we simply take the position off, lock in our profits, or buy back the short call and continue to sell more calls. Either way, we are left with a profit.

Quick Summary of Poor Man’s Covered Call Strategy

I like to take a diversified approach, using stocks that fall into different levels of IV, but risk is in the eye of the beholder, and I just want to make everyone aware of the choices out there so that we can make the most informed decisions possible given our own risk tolerance and investment goals.

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.

11 comments on “How to Use Poor Man’s Covered Calls on Lower-Priced Stocks

  1. Chris Howell on

    I’m new to options and trying to understand what happens in the longer term. When you said “we simply take the position off”, what does that mean? Thank you for your help.

    Reply
    • Andy Crowder on

      Chris,

      Thanks for the question. Feel free to ask whatever questions you have along the way to learning about options. Poor man’s covered calls, or diagonal call diagonal spreads are a bullish-leaning options strategy that acts very much like a covered call strategy. Without going into too much detail the main difference is that you are buying LEAPS as an alternative to buying stock. This makes the strategy significantly cheaper while still taking advantage of benefits of selling premium like that in a covered call. Moreover, the cheaper cost allows you to diversify amongst a basket of stocks. When I state get out of the trade, we simply close out the trade (at any point we wish) by selling our long calls and buying back our short calls or simply allowing them to expire worthless. I hope this helps and please don’t hesitate to ask any further questions.

      Reply
      • Jeff on

        How would you manage the short call in this scenario? Take off at a certain profit %, say 50% and look for a rally to sell another call meeting your criteria or just hold the short through expiration? Pros and cons to both I know but I’ve never done a PMCC leap so potentially an optimal strategy, statistically, here. Thanks!

        Reply
        • Andy Crowder on

          Jeff,

          Thanks for the question. I typically wait until the delta of both the LEAPS contract and my short call are at parity. Once the deltas are the same the position can no longer make money to the upside. Oftentimes, I will make this prior to parity. As a result, I buy back the short call and sell move premium going out further in time. Unless I wish to take off the position and simply lock in profits on the entire position. I hope this helps. Please do not hesitate to post additional questions if you have any.

          Reply
    • Andy Crowder on

      No problem Ron, I’m glad that you are finding the info helpful. As always, don’t hesitate to ask any further questions.

      Reply
  2. Bill Rassano on

    Hello Andy. Do you personally use a stop on the LEAP? And if so what are your general guidelines?

    Another question I have on the strangle you discussed in another article; which was a great approach. Would you implement a strangle every month despite low or high Volatility?
    And what stop would you put on a strangle with let’s say a total credit of $1.00.

    I would really appreciate your input. This is just great stuff you write.

    Best
    Bill

    Reply
    • Andy Crowder on

      Bill,

      Once the delta pushes below 0.50 I look to roll my deltas back to 70 to 80, so that I can create a long delta position again, that is of course, if I wish to maintain the position going forward.

      Reply
  3. syed ali on

    Will u please explain why u r taking short call strike 15 to close to the stock price 14.62 why not it is 17 or 18 and do we have to close both calls or only short call and what will happen if stock price crosses 15 do we will be assigned and have to buy 100 shares???????????

    Reply
    • Andy Crowder on

      Syed,

      It’s is because the premium is so low in the higher strikes. The comments (and my responses) below the article should help to answer your additional questions.I hope this helps and thanks for writing in. If you have additional questions please do not hesitate to ask.

      Reply

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