The Poor Man’s Covered Call Trade Initialization Formula – April 22, 2024
The Poor Man’s Covered Call (PMCC) is a covered call writing-like strategy where LEAPS options are purchased instead of actual stocks or exchange-traded funds (ETFs). Weekly or monthly short calls are written against the long calls. LEAPS options have expirations between 9 and 24 months out. Typically, deep in-the-money (ITM) strikes are used because they have Delta values approaches “1”, and therefore mirror the price action of the stock itself. The strategy allows investors to enter covered call trades with less capital exposure because the LEAPS cost less than the stock itself.
BCI has developed a trade initialization formula which guides us to the most appropriate PMCC trades. The initial structuring of these trades should allow us to close at a profit, should share price rise exponentially, forcing us to close both legs of the trade.
What is the BCI trade initialization formula?
[(Difference between the 2 strikes) + (initial short call premium)] > Cost of LEAPS
The BCI PMCC Calculator will display a bold red YES if the trade structuring is appropriate. A NO will appear if the trade does not comply with the formula.
Hypothetical example of an appropriate PMCC trade
- 12/20/2023: BCI trading at $31.00
- 12/20/2023: BCI 1/17/2025 LEAPS $15.00 has an “Ask” price of $18.50
- 12/20/2023: BCI 1/19/2024 $35.00 call has a “Bid” price of $0.90
BCI PMCC Calculator
- The spreadsheet displays a bold YES, indicating that the trade aligns with our initialization formula guideline
- If both legs of the trade are closed due to substantial price acceleration, it will close at a profit of $2.40 per-share (blue oval)
- The initial short call return, based on this 30-day trade, is 4.86%, with an additional 21.62% of upside potential
- Maximum loss (if share price moves to $0.00) is $17.60
Discussion
The BCI PMCC trade initialization formula provides a guideline as to the suitability of our trades. We want to ensure that, if forced to close both legs of the trade, we will close at a profit. The PMCC strategy allows us to enter our covered call trades with less capital risk, however, the strategy is so much more than “covered call writing, but cheaper”. Be sure to master all the pros & cons of this strategy and all its moving parts before deciding if it is the right strategy for you and your family. It may or may not be.
Author: Alan Ellman