Poor Mans Covered Call Option

Poor Mans Covered Call

15 min read

What is a “poor mans covered call?” It is a long option covered with a shorter dated short call option. This article will discuss this in more detail. We will provide examples of using this approach to trade a Buy-Write strategy without the capital required to buy the stock.

A Buy Write strategy is a bullish trade strategy. A trader buys a stock and then sells a premium against the stock through a short call. The ideal situation would be to see the stock rise or lose the shares at expiration through automatic exercise. Or buy the call to close (BTC) at a lower price before it expires. We could start a new short-call position by selling to open (STO) a different expiration with a different strike.

This strategy can help a stock position that is not performing well. Or the poor mans covered call can be used on things that are trading quickly. It gives the trader a lower breakeven (BE) on their stock entry. To demonstrate that better – let’s use an example from PYPL stock.

The picture below shows that PYPL has traded strongly higher over the last few days. And it could close the big gap in the daily chart. But it has run so fast these past few days that any trader would be nervous.

Poor Mans Covered Call

Buy Write Example

A buy write is different than a poor mans covered call. So, let’s look at the buy-write first. On Jan 19th, suppose we bought 500 shares at an average price of 61.50. The stock looked like it would close near the session’s highs. We wanted to trade it up into the bigger gap close but had to be mindful of the fast moves already made.

Using the MAR 15 expiration, we SOLD TO OPEN (STO) 3 calls at the 65 strike for 3.15$ and two calls at the 62.50 strike for 4.35, giving us a total credit of 18.15. This price gives us a lower breakeven on the average share price. Now, our average share price is 43.65\$.

As long as the stock stayed above \$43.65, we wouldn’t lose money. And this was great assistance since things looked violent. We can set alerts around that 43.00 area and let this trade mature.

What have we gained here by selling these calls? First, we must sell stock at that strike price if they are ITM at expiration. That’d be ok. We had an average share price of 61.50. So, if we had to sell the stock at 62.50 and 65.00 a share, we’d profit from that.

We’d also profit from the credit collected. That premium we collected has dropped our average BE from 61.50 to 43.65. So if we had to sell the stock at 62.50 and 65.00\$, then we make \$10,175!

62.50-43.65 = 18.85 * 200 = $3,770 | 65-43.65= 21.35 * 300 = 6,405$

3770+6405= $10,175

Poor Man's Covered Call

Buy Write Gains

What did we gain from the short calls versus a stock trade? If we had bought the stock at 61.50 and sold it at 62.50 and 65.00, we would have gained \$1,050 (using the same exit price). There is a world of difference between these two positions!

62.50 – 61.50 = 1.00 * 200 = 200.00$ | 65 – 61.50 = 3.50 * 300 = $1,050

All of this is a consideration of the trade going in our favor. But we all know that trades can lose, too. Let’s continue to review the various outcomes.

If the stock is below the call strikes at expiration, we get to keep all the credit and our shares with a new breakeven of 43.65\$. Since we still have the shares, we can sell calls against these shares again and again.

But what if we didn’t have the funds to buy the stock and still wanted to do the trade? We could use the Poor Mans Covered Call (PMCC) to take the same play.

Poor Mans Covered Call

Suppose we liked this setup and didn’t want to buy the stock. We could use the poor mans covered call instead. Here is an example of how that would work.

PMCC

We can see everything that we could see before in the picture. We are at a critical point where the price has climbed fast. And it looks like it could break out to close the gap.

If the stock gets rejected here, the bullish momentum will likely offer a higher low (HL). And we could try to break through the resistance again later.

Rather than just buying the stock – we could buy a call. But the calls on this stock are costly. Plus, we must worry about the stock falling away from this resistance area and giving us a losing trade.

Looking at the JAN 2025 Calls on PYPL, we could buy an 80.00$ strike call for 5.32 (mid). As a result, giving us control over 100 shares. Suppose we buy 5 of those calls?

Options Chain PMCC

Poor Mans Covered Call Example

Now that we own five calls of this poor mans covered call (5 calls … 5.32 * 5 = 26.60 debit), we control 500 shares. Buying a call gives us the right to buy stock at that strike price (\$80.00 a share).

Right now, PYPL will close on the day near 62.00. So, how would it benefit us to buy the stock at 80.00 using calls when we could buy it on the open market at 62? Right now, it would not help. It does give us the chance to sell calls against the calls we own (just like if we owned the stock).

Remember that a short call has a risk to the upside. The stock could climb higher and higher in a massive run. If that were to happen when we’re in a short call, the cost of closing that call could be massive!

Because we have the right to sell stock at 80.00\$, we are covered. PYPL could rip into 200.00 a share, but our short calls would still be covered by these 80 strike calls we hold long.

So, we want to consider selling calls at the front expirations. Stay mindful of our “average share price” of 80.00\$. We do not want these short calls exercised against us. Therefore, if they go into the money (ITM), we must manage them before expiration.

PYPL Options Chain

Sell a Call

Generally, with a poor man’s covered call – I like to sell calls against my long calls using the options price as a guide. I own the 80-strike calls for JAN. But this is 364 days out! If we look at the 80 strike options closer to expiration, we will see that they do not have much value.

Above is a MAR 1 expiration 80 strike call selling for less than 0.40¢. Below is a MAR 15 expiration 80 strike call selling for less than 0.60¢ ea. So, do we need to sell a different expiration, or do we need to sell closer to the money to get more credit?

Poor Mans Covered Call

Needing a Poor Mans Covered Call

The calls we bought – are the “thing we needed” to cover our short position. But right now, we must set that aside and focus on selling calls. Don’t let that long call distract you other than remembering we bought five calls at 5.32$ ea. Before they expire, we need to either make a good move in PYPL to the upside or make our money back on the short calls.

That means we want to consider selling calls closer to the money and buying them back to close later at a lower price. If the options we sell go ITM before expiration, we will have to take a loss (buy them back at a higher price than we sold them).

Or we roll the position (roll out in time and higher up in the strike prices). Another thing we can do is exercise our long JAN calls and close the short calls at the same time (like a diagonal trade).

I like those MAR 1 expirations for almost 3.00 a call. These have 42 days until they expire. And if we are currently over-bought in PYPL, then a pullback makes sense.

This will collect a lot of premium in less than 42 days. Meaning we would have greatly reduced our total risk in the trade. And then, if things go well, we can back off and not be so aggressive on the next set of calls we sell.

Options Order PMCC

Poor Mans Covered Call Buy to Close

In the picture below of the poor mans covered call – the green shaded area is the buy-to-close order. On Feb 9, we were able to Buy To Close (BTC) the calls at 0.21¢ debit.

We made a profit of $2.75 per call (2.96 – 0.21 = 2.75$) … (5 calls, so 2.75 * 5 = $13.75). We started all this with five long calls and a debit of 26.60. Therefore, we just reduced our risk by 13.75. (26.60-13.75 = $12.85).

Buy to Close

Why did the trade work so well? And why were we able to close so quickly? Look at the drop on the stock chart below. Earnings hit – dropping the stock price down considerably. The calls we sold could lose value very fast!

PMCC Chart

Second PMCC Example

Here is another poor mans covered call example. We can sell another 5-lot of calls. But this time, we will use a 62.50 strike to get more premiums. We also use APR options to give the market a little time after earnings. Selling five calls at 1.41 offers a total of 7.05 in premiums. (1.41 *5 = 7.05).

Sell PYPL

We can keep the premiums if the stock closes under 62.50 at expiration. Or once they decay enough, we can buy the calls to close at a lower price (just like last time).

Poor Mans Covered Call

See the picture above. On the 19th, PYPL barely closed under the 62.50 strikes, and we could BTC these contracts for 0.05¢ each. I thought this was a little too close for comfort. However, if needed, I was willing to attempt a roll before the close.

Buy Sell

Our profit was 6.75 (1.35 *5 = $6.75). We still owed on our long calls ($12.85), so we can take the debit on those long calls minus the profit made here and see a new debit (12.85 – 6.75 = $6.10).

We still own (5) JAN 17 calls, which we bought for 26.75, but now our total risk is only 6.10$. Per call – that is 1.22$ each. We have reduced our risk considerably. A few more short call sells, and we could get these long JAN 17 calls total risk down to zero!

PYPL Buy

Third Poor Mans Covered Call Example

On APR 19, I decided to try another poor mans covered call, selling some MAY 10 65 strike calls for a short-term expiration. I went with a short-term expiration because of earnings due on APR 30. As we can see from the picture, the stock closed under 65.00 on May 10. And we were able to let these options expire with worthless OTM.

Poor Mans Covered Call

Here is a picture just a few minutes before the close. We STO 5 contracts at 2.26 ea. and made a profit of 11.30$ in credit. We only owed 6.10$ on those long calls we had bought – so now the risk in those is completely clear.

PMCC May

FEB 9: 13.75 credit | APR 19: $6.75 credit | MAY 10: $11.30 TOTAL: $31.80 credit.

We bought those JAN 17. $80 strike calls for a total debit of 26.60$. We’ve made 31.80$ selling calls on those calls we own. However, we still have 249 more days until these JAN 17 calls expire.

By subtracting the JAN 17 debit from our profit, we have made 5.20$ no matter what. Those JAN 17 calls can go to zero – we would still have our 5.20$ profit.

Choices

We have a few poor mans covered call choices here. We can close the long calls here. As the picture below shows. We are selling them at 3.20$ each for a total of 16.00$. That would mean we lost 10.60 in that transaction but made 31.80$. We are recouping 16.00 from those calls. In total, we have 31.80 – 10.60 = $21.20 in profit.

We could keep the long calls and continue to sell calls against them. They could decay in value more. But we have plenty of time to sell more options and make more premiums.

To make this choice, we should consider how things have changed since Jan 19, 2024, when we started this trade. Earnings have been rough. The stock has struggled to rise. The options premiums are much less than they were in January.

We would want to consider the chances of the original trade making a profit (those 80 strike calls) and determine if we should move on to something else or continue to trade these options.

PMCC Example

This article discussed a continued Poor Mans Covered Call position from Jan 19, 2024, into MAY 10, 2024. We have covered a LOT of material, and you should take the time to review and consider it carefully.

FEB 9: 13.75 credit | APR 19: $6.75 credit | MAY 10: $11.30 TOTAL: $31.80 credit.

In February, we made $13.75; in April, we made $6.75; and in May, we made another $11.30 in profit. Things worked well, and everything turned out well. However, these trades were often at risk because of earnings and sharp moves in the stock. Make sure to understand these risks.

What to Look For

  • You’re taking a bullish, neutral position when you sell covered calls. You are long a call (similar to being long stock). As a result, you do not want to see the stock breaking support and falling.
  • How can you find that out? By looking at candlesticks and patterns along with support & resistance.
  • You will want to see premiums elevated – something along the way of an implied volatility greater than 40 (but less than 80)
  • You’ll want to see “weekly” options until you become more experienced.

Some Things to Avoid

Some things can make trading options difficult, like a poor man’s covered call. If you avoid these things, you will likely avoid complications and losses. We want to avoid dividend dates, earnings, and scheduled events (like investor day events or new product launches) and avoid stock splits.

High-volatility stocks are another thing to avoid. However, this is a two-sided argument.

We want to sell options with a higher premium (options inflated due to increased volatility) while avoiding trades on stocks acting violently or showing a lot of volatility.

Try not to seek out the highest volatility markets – while also not seeing out the lowest volatility markets. A stock with an implied volatility above 40 is considered ok, while a stock with an implied volatility greater than 80 would be considered dangerous.

Things to Consider

The stock market is a battle of buyers and sellers. It’s what moves the market. Without that battle, there’s be no price action. Without price action, no one would make any money.

Candlesticks are the foundation of trading. Without candlesticks, technical analysis means nothing. By themselves, candlesticks tell a story. However, group them, and you’ve got patterns.

These patterns, coupled with technical analysis and support and resistance, will give you a pretty clear picture of the type of trade you should be making.

Delta – Traders can use Delta as a “probability of expiring ITM” to help them consistently build positions with a “better than 50% chance of profit,” which gives them an edge over the “buy side” traders. To do this – look at the Delta on the options chain and choose a strike with a Delta lower than 50%.

Practice

Make sure you practice trading a poor mans covered call. Before selling to open (STO) Covered Call positions – consider trading in paper to get familiar with the decay style of options and how the options prices will change when the price places that option ITM.

Get familiar with working the order to fill the trade at mid or better (to open a short trade) and to fill again at mid or less (to close a short trade). As sellers, we want to use STO for as much money as possible and buy to close (BTC) for the least amount.

Final Thoughts: Poor Mans Covered Call

You are trading a covered call just like a buy / write covered call. Except that your coverage is the call you bought to open the trade. The call you buy needs enough time for you to sell calls. So, do not trade the long and the short sides too closely together in time.

Just like a buy-write call option can lower our average share price, a poor mans covered call can lower our average long call price. When we close the short call in profit, it reduces our long positions’ risk.

The closer ATM the long call is – the more premium it takes to buy that call. But the farther OTM you are in that long call – the more margin you need if you sell calls closer to the money. Either way – this takes capital to perform and is difficult to do in smaller accounts.

It’s advised to close the short calls before they expire – as the trade P&L gets violent as it nears expiration (a common theme is to close the position near 50 to 60% of max credit).

If you need more help – consider taking our options trading course and join our Discord to ask the moderators questions that you may have.

Frequently Asked Questions

The assignment isn't the same as a poor mans covered call. If your long call is deep ITM, you can offset your short stock position.

The maximum loss is the amount you spend on the trade. 

You must accept the assignment and sell the stocks at the strike price you bought them. 

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