Selecting the Best LEAPS Strike for an AAPL Poor Man’s Covered Call Trade – August 14, 2023
The Poor Man’s Covered Call (PMCC) is a covered call writing-like strategy where deep in-the-money (ITM) LEAPS options replace the long stock positions. LEAPS have expirations of greater than 1 year. Once the LEAPS is purchased, we then sell a call option, establishing our covered call-like trade. In traditional covered call writing, the short call strike is based on our initial time-value return goal range, say 1% – 3% per month (as 1 example). This article will discuss how the LEAPS strike is selected, using a real-life example with Apple, Inc. (Nasdaq: AAPL).
Time-value of ITM LEAPS strikes
As the call strike moves deeper ITM, the time-value component of the premium decreases in value. The total premium will increase due to the greater intrinsic-value component, but the time-value will decline. This is critical to understand as it relates to how we establish the appropriate LEAPS strike when establishing our PMCC trades.
PMCC trade initialization formula
When we set up our PMCC trades, we must establish that, if we are forced to close the trade due to significant share price appreciation, we close at a profit. Here is the formula that will ensure this:
[(Difference between the 2 strikes) + (initial short call premium)] > Cost of LEAPS
When this formula is successfully adhered to, our BCI PMCC Calculator will show a bold red “YES” If not, a bold red “NO”
Short call option-chain for AAPL (4/21/2023 expiration)
With AAPL trading at $160.20, we will look to sell the $162.50 strike at $3.60. This will generate option premium and allow for share appreciation up to the $162.50 out-of-the-money strike.
LEAPS option-chain for AAPL (1/17/2025 expiration)
We will evaluate the $80.00 strike to see if the formula is met. If not, we will move deeper ITM to the $60.00 strike.
BCI PMCC Calculator using the $80.00 LEAPS strike
The bold “NO” means the formula has not been satisfied, with a potential closing loss of $1.65 per-share. We will now calculate with the deeper ITM $60.00 LEAPS strike.
BCI PMCC Calculator using the $60.00 LEAPS strike
- The bold “YES” means the formula has been satisfied, with a potential closing gain of $0.90 per-share if we are forced to close the trade early due to substantial share appreciation
- The initial 26-day time-value return is 3.42%
- The upside potential to the OTM strike is 2.19%
- The maximum 26-day return is 5.61%, 78.73% annualized (as a frame of reference)
Discussion
When establishing our PMCC trades, we must ensure that we have adhered to our trade initialization formula. If the BCI PMCC calculator shows a bold “NO”, we should calculate LEAPS strikes deeper ITM until we generate a bold “YES”
Author: Alan Ellman