Questions we’ll answer in this discussion:
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What is it
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Who is it for
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When to use it
The Poor Man’s Covered Call is a very specific type of spread. As you know, we’ve been covering option spreads for several Coffee With Markus Sessions.
We have an upcoming Covered Call class that will discuss this strategy and more.
We’ve also covered the Covered Call’s strategy in-depth on our YouTube Channel.
In this article, we’re discussing the difference between trading stocks, covered calls, and the Poor Man’s Covered Call.
Trading Stocks
Let’s take a look at trading stocks first. Let’s say that you’re bullish on a stock like Boeing (BA). If you were bullish on this stock, you might purchase a decent amount of stock, let’s say 100 shares.
Right now this stocks strike price is $180. If you purchased 100 shares of Boeing, at $180 dollars each, this would require $18,000 in purchasing power.
If the stock increases by $10, to $190, you stand to earn $1,000 in net profit. So you’ve risked $18,000 to earn $1,000. If the stock price increases to $200, you’ll earn $2,000 and so on.
This is pretty basic and you probably understand this concept.
As you can see in this image, the sliding scale moves to the right as the stock price increases.
This scale is called a profit picture. It is a visual representation of your profits. or losses depending on the movement of the stock. In this example, the price of the stock is increasing so the scale is moving to the right.
Trading Covered Calls
In this example, let’s say that you’re still bullish on Boeing. And in the short term, you expect an upward movement in price.
Since you already own the 100 shares of Boeing stock, you can sell a $200 Call Option against these shares.
If the stock price increases to $190 like you expect, you’ll earn an additional $450 on top of the $1,000 you’ve already earned. If we see a decrease in stock price, the covered call acts as a hedge.
In this example, if we saw a downward movement to $170 you would lose $1,000. But because you sold a $200 Call option contract and received a premium of $450, your net loss would only be $550.
Covered Calls VS Poor Man’s Covered Call
Poor Man’s Covered Call
When would you trade a Poor Man’s Covered Call? That’s easy! When you don’t have the $18,000 to buy 100 Boeing shares!
And When do you trade a covered call? When you expect the stock to stay above the current price and move slightly higher.
Instead of buying a stock, you would purchase a deep in the money call option at a later expiration.
When looking for a call option deeper in the money, we’re trying to find one with a Delta of 0.95. This means for every dollar the stock moves, the call option is gaining .95 cents in value.
In this image, we can see the options chain on the Boeing options contracts. This window is where we find the Delta and ensure that we’re choosing the right contract for the poor man’s covered call strategy.
Deep “In The Money” Calls
For this example, We’re buying a deep ITM call at $71 which means the capital required to take this position is only $7,100.
As you can see this is a fraction of the price to purchase the stock outright. At the same time, we will sell the $200 Call option. Similar to the covered call.
But instead of owning the stock at a price of $18,000, we purchased the ITM call option and sold a $200 call option.
if the underlying stock price moves from $180 to $190 you would make $1335 because the Delta is 0.95, which means it’s only increasing 95% of the value.
The profit on this type of position isn’t as high as a covered call, but it’s much more than owning the stock outright, with much less risk and less capital.
This sounds too good to be true right? The perfect strategy! BUT… there’s a downside associated with this strategy.
Your profit is limited. If you see a huge movement in the underlying stock, you’ll only benefit from a portion of the total gains.
In this example, if the underlying strike price gained $40, the stockholder would earn $4,000. The covered call would earn $2450, and the Poor Man’s Covered Call would earn $2,320.
Many traders use this strategy because of the limited capital involved with taking on a position, and the limited risk associated with a potential downward movement of this stock.
Trading Futures, options on futures and retail off-exchange foreign currency transactions involves substantial risk of loss and is not suitable for all investors. You should carefully consider whether trading is suitable for you in light of your circumstances, knowledge, and financial resources. You may lose all or more of your initial investment. The lower the day trade margin, the higher the leverage and riskier the trade. Leverage can work for you as well as against you; it magnifies gains as well as losses. Past performance is not necessarily indicative of future results.
Editors’ Picks
EUR/USD clings to daily gains above 1.0650
EUR/USD gained traction and turned positive on the day above 1.0650. The improvement seen in risk mood following the earlier flight to safety weighs on the US Dollar ahead of the weekend and helps the pair push higher.
GBP/USD recovers toward 1.2450 after UK Retail Sales data
GBP/USD reversed its direction and advanced to the 1.2450 area after touching a fresh multi-month low below 1.2400 in the Asian session. The positive shift seen in risk mood on easing fears over a deepening Iran-Israel conflict supports the pair.
Gold holds steady at around $2,380 following earlier spike
Gold stabilized near $2,380 after spiking above $2,400 with the immediate reaction to reports of Israel striking Iran. Meanwhile, the pullback seen in the US Treasury bond yields helps XAU/USD hold its ground.
Bitcoin Weekly Forecast: BTC post-halving rally could be partially priced in Premium
Bitcoin price shows no signs of directional bias while it holds above $60,000. The fourth BTC halving is partially priced in, according to Deutsche Bank’s research.
Week ahead – US GDP and BoJ decision on top of next week’s agenda
US GDP, core PCE and PMIs the next tests for the Dollar. Investors await BoJ for guidance about next rate hike. EU and UK PMIs, as well as Australian CPIs also on tap.
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