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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.
Directional Assumption: Bullish
- Buy an in-the-money (ITM) call option in a longer-term expiration cycle
- Sell an out-of-the-money (OTM) call option in a near-term expiration cycle
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
Ideal Implied Volatility Environment: Low
Max Profit: The exact maximum profit potential cannot be calculated due to the differing expiration cycles used. However, the profit potential can be estimated with the following formula:
Width of call strikes - net debit paid
How to Calculate Breakeven(s): The exact break-even cannot be calculated due to the differing expiration cycles used in the trade. As a rough estimate, the break-even area can be approximated with the following formula:
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.
When do we close PMCCs?
In the best case scenario, a PMCC will be closed for a winner if the stock prices increases significantly in one expiration cycle. This is because the call options will trade closer to intrinsic value and the profit potential for the trade will diminish.
When do we manage PMCCs?
For losing trades due to the stock price decreasing, the short call can be rolled to a lower strike to collect more credit.
Market Data provided by CME Group & powered by dxFeed Technology. Options involve risk and are not suitable for all investors.
Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
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