Buy Write Covered Call Trading Strategy

Buy Write Covered Call Strategy

8 min read

What’s a buy write covered call? With options, there are a ton of different strategies. Write buy vs covered call. Naked options or spreads. You can make money in any market. Whether up, down or sideways. However, you have to know what you’re doing with options. They’re not as cut and dry as you might hope. But don’t let that scare you!

Have you ever heard of a buy write covered call? Well, if you have big trade plans but limited working capital, listen up. Options are a great way to maximize leverage while minimizing risk. In this article we are going to discuss a strategy know as the Poor Mans Covered Call or PMCC for short.

Take our advanced options strategies if you’re looking to learn how to buy write covered calls.

Buy Write vs Covered Calls

The buy write covered call position is considered a synthetic position. Why? Because you’re using your opinion to buy 100 shares of stock as leverage to sell covered calls.

One benefit is that you only need a fraction of the capital required to buy 100 shares of stock in selling each traditional covered call.

The strategy is to buy an in the money call with an expiration at least 6 months out or more. And sell a covered out of the money call with an expiration date that’s a month or less out against it. Pretty easy right? But there are a few things you must know about eh buy write vs covered call in order make the trade profitable.

What’s the Objective?

The objective is to take advantage of time decay on the short call. However, it can take a week or more to realize any profit. This doesn’t work on penny stocks. The ideal equity will have a share price of about $40 or more.

On the bright side you will have control of $4,000 or more worth of stock; while only having to lay out a few hundred dollars or more. The position can definitely move against you. But you’ll have plenty of time to react. Time decay and price degradation of the short call will give you quite a bit of cushion if the trade does go against you.

One thing you can do is buy the short call back for less than you sold it for.  Then sell it again later for more than you bought it for. Remember you have time on your long call.

It’s very important to pay attention to is the break even price of both your long and short calls. The difference between them is your profit margin.The break even price on your short call must always be greater than the break even price on your long call. This way if you are assigned you are guaranteed profit.

Ever Hear the Phrase “Time Is Money”?

My take on the phrase is “More Time is More Money”. I like LEAPS. But I like them more when they are free. The more time you have on your long calls the more time decay you can take advantage of on your short calls.

Time decay on a LEAP is very minimal. And time decay on monthly options is brutal. In terms of the “Theta Gang” this would make you a “Theta Kingpin. The strategy is to buy to open (BTO) an in the money (ITM) call with an expiration date a year or more out. I prefer deep in the money (DITM) with my long call that’s a year out.

But I really like to start with a call that’s 2 years out or more depending on Delta. Sometimes an extra year is not too much more premium outlay. Once you have established your long position it is time to start selling premium. The typical PMCC is a simple diagonal calendar spread with the intention of closing the position when profitable.

But by now, you know that I love to reduce my cost basis by almost literally renting out my long position on a month to month basis.

Breaking Down the Buy Write Covered Call

The buy write vs covered call method to my madness is a little complex but I’m happy to break it down for you. There are some equities where you can have a diagonal spread that’s only a few months wide and a few strikes vertical. These short term PMCCs are typically low risk low reward; but pretty good probability of profit. However if it starts to move against you, it leaves little chance of exiting with a profit. This is why I would rather have a long position that is years out.

What’s the Catch?

The catch is that you must make sure that you always know the break even price of your long position. The idea is to always expect your covered call to be exercised.The difference between your break even and the break even on the covered call should always be a positive number.

Example: let’s say that I paid $5.00 premium for a $40 strike call. My break even price is $45 per share. To make a profit I must only sell a covered call with a strike price that has a break even price above my break even price.

When selling monthly covered calls that profit margin will be pretty small at first. But remember, you must manage your risk. You must also remember that each monthly covered call that expires worthless or is bought to close (BTC) for less than you sold to open (STO), that profit will reduce your break even price and essentially your cost basis.

After a few months without being assigned on your covered calls your break even will be significantly reduced and your profit prospects will become more lucrative.

Price Action

Daily price action works the same for almost every option strategy in my wheelhouse. Opening bell hour and power hour always have the highest implied volatility.Those are the times you will want to focus on when selling your covered calls. The middle of the day is when you’ll likely want to buy your long calls. But it’ll not have nearly as much affect on LEAPS.

This can be a very passive strategy but I am anything but passive. You can buy and sell options over and over again if you want to take advantage of the daily price action. But be mindful that PDT rules still apply to options.

When traded passively, it can take more than a year to cover the cost of the long call that is 2 years out. When I trade the daily price action I can usually cover the cost of my long calls in 7 to 11 months.

When to take profit. You can close this trade any time you want. But you’ll likely want to take profit on a much longer duration once you have closed a few short calls. Here is where you want to consider a few choices.

You can close your position and move on after a few months or you can hang it out all the way to within a few months of your long call expiration.At that point you can either sell the long call and buy back your short call or you can simply exorcise your long call if you have the cash. You can also roll your long call out another 2 years and open the position again.

Buy Write Covered Call and Start Simple

Start simple. Find an equity with a little volatility but an established long term bullish trend. This would have been much easier before the pandemic however a lot of sector rotation is starting to take place.You primarily want to stick to slow and steady instead of rapid growth. The idea is that you want to keep your risk low and your reward steady but highly probable.Over time that reward will grow even if the equity you choose goes sideways for a year. Set a reasonable stop loss that allows a little more wiggle room than you would if you were just swing trading.My stop loss for swing trading is just 4% but my stop loss for the PMCC is 25%. That LEAP gives you lots of time to recover and selling monthly covered calls will give you an edge to expedite a recovery.Choose a reputable company to trade. Don’t try this on a fly by night Chinese electric car company.

Final Thoughts

If you feel compelled to trade this strategy on a penny stock, go with GE or something that isn’t going to file chapter 11 or dilute the equity.

GE won’t make you a killing any time soon with the buy write covered call strategy but it might be a good back test or practice trade.

As always please fully understand how this strategy works before you try it. You’ll have to take a stand against FOMO. You may get a little disheartened seeing a 15% loss on your screen for a few days but believe me patience will pay off in the long run.

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