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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.
The trade will be entered for a debit. It’s important that the debit paid is no more than 75% of the width of the strikes.
Stock at $100
Purchase (Expiration 2) 90 call for $15
Sell (Expiration 1) 110 call for $5
Net debit = $10.00 on a 20-point-wide long call diagonal spread
HOW TO CALCULATE MAX PROFIT / BREAKEVEN(S)
The exact maximum profit potential & breakeven cannot be calculated due to the differing expiration cycles used. However, the profit potential & breakeven area can be estimated with the following formulas.
Width of Call Strikes - Net Debit Paid
Long Call Strike Price + Net Debit Paid
A Poor Man’s Covered Call is a fantastic alternative to trading a covered call. In smaller accounts, this position can be used to replicate a covered call position with much less capital and much less risk than an actual covered call.
The setup of a poor man’s covered call is very important. If we have a bad setup, we can actually set ourselves up to lose money if the trade moves in our direction too fast. To ensure we have a good setup, we check the extrinsic value of our longer dated ITM option. Once we figure that value, we ensure that the near term option we sell is equal to or greater than that amount. The deeper ITM our long option is, the easier this setup is to obtain. We also ensure that the total debit paid is not more than 75% of the width of the strikes.
We never route poor man’s covered calls in volatility instruments. Each expiration acts as its own underlying, so our max loss is not defined.
Close / Manage
In the best case scenario, a PMCC will be closed for a winner if the stock price increases significantly in one expiration cycle. This is because the call options will trade close to intrinsic value and the profit potential for the trade will diminish.
For losing trades due to the stock price decreasing, the short call can be rolled to a lower strike to collect more credit.
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