The Poor Man’s Covered Call: How to Re-Structure a Potentially Losing Trade into a Winning One – April 24, 2023
The Poor Man’s Covered Call is a covered call writing-like strategy where a LEAPS option is used as a surrogate for the actual stock or exchange-traded fund (ETF). When structuring our PMCC trades, we must make sure it aligns with our required initial structuring formula. This will allow us to close our PMCC trades at a profit if the share price rises exponentially and we are forced to close both legs of the trade.
Why would we be forced to close both legs of the PMCC trade if share price moves significantly higher?
If stock or ETF price rises well above the short call strike, we would be required to pay a high intrinsic-value component to buy back the short call to avoid exercise and roll the option. We may not have the capital or the motivation to add significant resources to this trade and opt to close, preferably at a profit.
PMCC required trade initialization formula (Inherent in the BCI PMCC Calculator)
[(Difference between the 2 strikes) + initial short call premium] > Cost of LEAPS option
Factors that influence the appropriateness of our initial trade structuring
- LEAPS have wider bid-ask spreads than near-the-money short calls and this must be overcome
- Deeper in-the-money (ITM) LEAPS strikes have lower time-value components to the premiums than those closer to the current market value
- The BCI PMCC Calculator will show a “YES” or a “NO” to reflect if the trade entries are appropriate for initial trade structuring
- If “NO”, use a deeper ITM strike until a “YES” is posted
Real-life example with Walgreen Boots Alliance Inc. (Nasdaq: WBA: $40.01): Short call option-chain
Real-life example with WBA: 1/17/2025 LEAPS option-chain showing $35.00 and $27.50 strikes
If we do the math, we will calculate the time-value component of the $35.00 strike to be $4.84 and that of the $27.50 strike to be $2.04, confirming that deeper ITM strikes have smaller time-value components.
PMCC calculations with the $35.00 LEAPS strike: “NO”
If forced to close this trade, it will be at a loss of $1.98 per-share (red arrow).
PMCC calculations with the $27.50 LEAPS strike: “YES”
If forced to close this trade, it will be at a profit of $0.82 per-share (red arrow).
Discussion
When establishing our PMCC trades, we must adhere to the BCI initial structuring formula. Bid-ask spreads and time-value components of our premiums play major roles in these decisions. If the trade is deemed not appropriate, we look to deeper ITM LEAPS strikes with lower time-value components (also, greater intrinsic-value costs). The BCI PMCC Calculator will do all the mathematical legwork for us.
Author: Alan Ellman