How to Adjust a Poor Man’s Covered Call (PMCC) Trade to Align with the BCI Trade Initialization Formula – June 05, 2023
The PMCC is a covered call writing-like strategy where LEAPS options act as surrogates for the underlying stock or ETF. It is technically called a long call diagonal debit spread and has the advantage of lower cost to enter the trade when compared to traditional covered call writing. Short (covered) calls are sold against this long LEAPS position.
What is the BCI trade initialization formula?
When we structure our PMCC trades, we want to be sure that if we are forced to close both legs of the trade if share price appreciates substantially, we can close at a profit. The required formula is:
[(Difference between the 2 strikes) + (initial short call premium) > cost of LEAPS
BCI PMCC Calculator
The Initial Trade tab is designed to let us know if the proposed trade meets the formula requirements, generating a YES or a NO. If the spreadsheet shows NO, an adjustment is necessary.
Rationale behind the PMCC adjustment to generate a YES
If the spreadsheet rejects the trade, it is typically because the time-value component of the cost of the LEAPS is too large and a different, lower strike LEAPS must be selected. The deeper in-the-money the strike, the lower the time-value component of the option premium.
Real-life example with Apple Inc. (Nasdaq: AAPL): Trade rejected
The time-value component of the $120.00 long LEAPS strike is too expensive, and we must try a deeper ITM strike.
Real-life example with Apple Inc. (Nasdaq: AAPL): Trade accepted
Discussion
When crafting our PMCC trades, we must consider the possibility of significant share appreciation early in the trade cycle, forcing us to close both legs of the trade. To accomplish this, we turn to the BCI trade initialization formula or the 1st tab on the BCI PMCC Calculator. When the spreadsheet rejects the trade, we must try lower ITM strikes to decrease the time-value cost of the LEAPS until we read a YES in the spreadsheet. Yes, this will cost us more cash to enter the trade, but it also protects us from a potential loss even when we are directionally correct.
Author: Alan Ellman