Ep. 219: The Poor Man's Covered Call Explained

Poor Man's Covered Call Explained - Proven Trading Strategies Simple and Easy
he Poor Man's Covered Call

Questions we’ll answer:

What is it
Who is it for
When to use it

The Poor Man’s Covered Call is a very specific type of spread.  As you know we’ve been covering option spreads for several Coffee With Markus Sessions. 

We have an entire playlist discussing the pros and cons of each type of options spread. 

In this video, we’re discussing the difference between trading stocks, covered calls, and the poor man’s covered call. 

Trading Stocks

Let’s take a look at trading stocks first. Let’s say that you’re bullish on a stock like Boeing. You might purchase a decent amount of stock, let’s say 100.  Right now this stocks strike price is $180.  If you purchased 100 shares of Boeing, at $180 dollars each, this would require $18,000 in purchasing power. If the stock increases by 10 dollars, to $190, you stand to earn $1,000 in net profit.  So you’ve risked $18,000 to earn $1,000. 

Trading Covered Calls

In this example, let’s say that you’re still bullish on Boeing. And in the short term, you expect an upward movement in price. Since you already own the 100 shares of Boeing stock, you can sell a $200 Call Option against these shares. If the stock price increases to $190 like you expect, you’ll earn an additional $450 on top of the $1,000 you’ve already earned. If we see a decrease in stock price, the covered call acts as a hedge. In this example, if we saw a downward movement to $170 you would lose $1,000.  But because you sold a 200 Call option contract and received a premium of $450, your net loss would only be $550. 

Poor Man’s Covered Call

When would you trade a Poor Man’s Covered Call? When you don’t have the $18,000 to buy 100 Boeing shares!  When do you trade a covered call? When you expect the stock to stay above the current price and move slightly higher. Instead of buying a stock, you would purchase a deep in the money call option at a later expiration. When looking for a call option deeper in the money, we’re trying to find one with a Delta of 0.95. This means for every dollar the stock moves, the call option is gaining .95 cents in value. 

We’re buying a deep ITM call at $71 which means the capital required to take this position is only $7,100. As you can see this is a fraction of the price to purchase the stock outright. At the same time, we will sell the 200 Call option. Similar to the covered call. But instead of owning the stock at a price of $18,000, we purchased the ITM call option and sold a 200 call option.  

if the underlying stock price moves from $180 to $190 you would make $1335 because the Delta is 0.95 which means it’s only increasing 95% of the value. 

The profit on this type of position isn’t as high as a covered call, but it’s much more than owning the stock outright, with much less risk and less capital. 

Trading Futures, options on futures and retail off-exchange foreign currency transactions involves substantial risk of loss and is not suitable for all
investors. You should carefully consider whether trading is suitable for you in light of your circumstances, knowledge, and financial resources.
You may lose all or more of your initial investment. The lower the day trade margin, the higher the leverage and riskier the trade. Leverage can
work for you as well as against you; it magnifies gains as well as losses. Past performance is not necessarily indicative of future results.

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Markus Heitkoetter