Poor Man’s Covered Call — Introduction and Real Trade Analysis

The Poor Man’s Covered Call (PMCC) is an options strategy that enables one to sell covered calls at a fraction of the capital required than if he were to hold the underlying asset. The following is quoted from what TastyTrade defines a PMCC is:

A “Poor Man’s Covered Call” is a Long Call Diagonal Debit Spread that is used to replicate a Covered Call position. The strategy gets its name from the reduced risk and capital requirement relative to a standard covered call.

I am a fan of the Wheel strategy (which involves selling cash-secured puts, selling covered calls in a loop with stocks involved), and the covered call writing is part of the wheel strategy. Personally, this strategy is a low risk and high reward strategy, if the right stocks and right way are applied to manage the trade. However, this strategy generally only works on stocks that are neutral or slightly bullish. With the current market conditions, I am slightly hesitant to enter any positions as even good and strong stocks are falling due to market fear. The PMCC will limit the absolute loss of this strategy since your required capital is much lower, but do note that in terms of percentage, you will probably lose more, since there is time decay involved in options but not in stocks, and you can hold stocks for as long as you want till it recovers. This is why managing the position is so important compared to just covered call writing.

What is a PMCC actually?

The typical PMCC consist of two call options.

1. A long deep in-the-money (ITM) LEAPS call option (~0.80 Delta). This call option acts like a stock, it gives you the coverage of selling a call option, and being deep ITM, the 0.8 Delta will ensure the option moves as close to the stock as possible. There is some flexibility here, some people like going for 0.7, while some like to play it safe and go for 0.9 Delta. Any way works, depending on your risk appetite. LEAPS, which stands for Long Term Equity Anticipation Security, are options that expire much much later. You can find LEAPS that expire as far as about 2years later. LEAPS are used because they are the least affected by time decay compared to nearer-term options. I generally go for the furthermost possible LEAPS, to buy myself more time, do note that you will be paying more for time decay so longer LEAPS will be more expensive.
2. A short out-of-the-money (OTM) call option (~0.30 Delta). Selling an OTM call option allows one to collect some income while holding on to a particular stock, and also sell it at a higher price if the option gets exercised. I generally go for 0.3 Delta as this is close to the 1 standard deviation of where the stock would move to (1SD =68%). Some people sell these calls weekly, some sell them monthly, I personally prefer to do it weekly because I’m slightly more active in monitoring the markets and any unexpected moves I would be able to manage it accordingly.

My current positions:

I have opened 4 PMCC positions so far, 2 have been closed while 2 are currently still open. I will cover each position and show the pros and cons of the PMCC.

1st Trade: Bank of America (BAC) — CLOSED

I purchased a BAC LEAP Call option expiring 15Jan2021 with a strike price of $25 for $600 on 2Apr2019. The stock price then was $28.50. This means that from now till 2021, I can choose to buy 100 BAC shares for $25 each. This might be confusing to newer options traders or nontraders, the standard question would be “Hey K, why don’t you just exercise the option now and purchase the stocks at $25 and sell it at $28.50? You will make $350 in total instantly!” That is absolutely true! But don’t forget how much you paid to buy this ‘right’ to purchase the stock at $25. $600! That would mean you would have an instant loss of $250! If making money was that easy, everyone would be rich! Okay going back to the topic, you can ignore the closing position for now, as we look to the short side to see what trades were taken.

I sold a 2-week expiry remaining call option and collected a premium of $0.32. The current stock price is $28.50, and my strike is $29.50. As long as the stock price does not hit $29.50 at expiry, I will be able to keep the full premium. Note that even if price rally above $29.50 but falls back below this level by expiry, I will still be able to collect the full premium as the option will expire worthless. The goal is to let the short option expire because you are collecting a small amount of premiums, and would prefer not to close it to incur more commission fees. However, do note that some brokers do not charge if the value of your option is below a certain amount. For ToS that I’m using, any closing any position with a value of $0.05 or less, there is no commission charge. This entices me to close it earlier so I will not be subjected to more market volatility. As you can see above, I actually closed this position at a loss on expiration because the stock went past my strike price to $30. This means that I will be exercised at the end of the day. Normally I wouldn’t need to be scared because I do have my long position that I can exercise and give the shares to the buyer, but there will be an additional exercise fee of $15 if that happens. Always remember, we need to know all the cost of our trades and try to minimize it. Since my long position has a higher delta, the loss in my short position due to the up-move in the stock will be offset by the gains of my long position. I would still be profitable in the overall position.

This is the final summary of my trade. Although incurred a loss of $12 from the short call, my long call made $76. That means I made $64, on a $600 initial investment. After taking into account commissions, my net ROI is 11.77%, for a period of 16 days. Pretty decent if you ask me.

2nd Trade: Sketchers USA(SKX) —OPEN

Sketchers has been a solid stock with good fundamentals, and I foresee it to have a steady growth in the business as well as the stock price, which is why I chose it as a candidate for PMCC. I opened a 2021 LEAP option with a strike price of $30 and a premium paid of $1050. The stock price at open was $34.

Above table shows the short positions I had. I initially sold a monthly call option for $1.46, a 14% ROI trade! This was achieved with 9 days after Sketchers announced earnings and the stock price plunged. With only $0.05 value left in the option, i decided to buy it back to close it and realized my $141 profit. I waited to enter another position since there is also a good possibility that price might rebound after the sharp drop. After somewhat stabilising, I entered another short position on 30th Apr, this time choosing a weekly option to have better management of the trade. This trade expired worthless on 3rd May. by this time, SKX stock price as taken a beating and has fallen below $30, the strike price of my long option. This means that I’m no longer protected if should my short call gets exercise. I’m hesitant to take a position and waited on the sidelines to see where the price was heading. It never recovered. SKX broke past the 200SMA and should look to continue to drop in the short term. I decided to open a weekly position on 30th May to continue earning some small premiums to minimize my loss, if I’m right on the short term trend, I should be able to make some decent premium and hopefully breakeven.

The final summary will not be reflective of the trade as it treats my long position as a 100% loss until I close the trade so I will use this PMCC template I got online for a summary. As you can see, my current ROI from my short positions is about 16%, provided my opened short position expires worthless. However since I’m not covered, I will look to close my position on expiry day to prevent assignment. My current loss on my long position is $505, about 50%, so I’m about 34% down in this position. My strategy would be to continue selling tightly managed calls till about 2 weeks before the next earnings, and hope the stock price recovers.

3rd Trade: Bank of America (BAC) — CLOSED

Less explanation is needed now as the flow of the trade is the same. $830 of premium paid for a LEAP option.

My short positions. I closed 2 positions as they were below $0.05 and I didn’t have to pay commissions so there was no reason not to close it.

Final summary, lost $22 on my shorts, made $82 on my longs, net profit of $60, net ROI of 8.74% over a period of 11 days. BAC has also taken a beating with the trade war tensions and is sitting at $26.60 currently. It’s a great stock for the PMCC strategy and I’m looking to open one as soon as there is some stability in the markets.

4th Trade: NIO INC (NIO) — OPEN

I bought 5 contracts of NIO on 22Apr for the PMCC strategy. Personally, I didn’t think this stock was a good candidate because it didn't have strong fundamentals, and is probably super volatile. But I noted that the premium was really juicy and based on the charts, the odds of it falling below $4 seem unlikely. This is a case of ‘there are no such things as how low a stock can go’. It can ALWAYS go lower, and likewise, always go higher. This goes to show how important trade management is. As we all know, NIO is currently sitting at $3.05 lul. Being a Chinese EV company, this trade war will not be friendly to NIO at all. I’m even considering selling my LEAP at a loss now, but it’s uncertain how the trade war will play out in the coming months, so I will leave it for now.

My most actively managed position among the 4. Being a volatile stock, I had to close positions at expiration dates if the price was very near to the strike price to avoid assignment. Similarly, my long position is no longer covering my shorts so any selling I do will need to be managed accordingly.

My current ROI for my shorts is 23%, but my LEAP is down $627.50, about 60%. Similarly, I'm down 37% on NIO. Let’s see how this plays out in the coming weeks!

There you have it, my summary of what PMCC is and my actual trades. The 3 stocks I’m looking to open my next PMCC are AT&T, BAC, and JPM. Also, if you would like to use the above tracker to track your PMCC positions, go to:
https://www.youtube.com/channel/UCJ6LEmrY0tZEzwXwpaoF2ag
This guy is an advocate of cover called writing and shares his trades and thoughts, usually on a weekly basis. Pretty underrated in my opinion. All the materials on his site are free so there is no commitment and obligations at all. Check him out!