The Poor Man’s Covered Call (PMCC), also known as a long call diagonal debit spread, is where deep in-the-money (ITM) LEAPS options are used in place of the long stock position. As with all strategies, the PMCC has its advantages and disadvantages but the main reason this strategy appeals to retail investors is that the cost to enter this trade is much less than a traditional covered call trades. Options cost less than stocks.
Selecting the best Delta for our LEAPS options
The reason we use deep ITM LEAPS strikes is because the closer to a Delta of 1, the more the price movement of the option will mirror that of the stock. Therefore, the BCI guideline is to use a Delta of .75 or higher for our LEAPS strike. Since there will be several strikes to select from, we factor in the following:
- Cost of LEAPS must align with our portfolio cash available
- The strike selected must align with the BCI initial trade execution required formula
- The initial time-value returns must coincide with our stated goals
Real-life example with Intel Corp. (NASDAQ: INTC)
On May 18, 2020, INTC was trading at $58.30 and the $60.00 6/19/2020 $60.00 call option had a bid price of $1.75. The LEAPS option chain for the 1/21/2022 expiration showed 8 eligible deep ITM strikes with Deltas ranging from 0.779 to 0.9059:
INTC LEAPS Option-Chain
- Purple cells: Cost of LEAPS
- Yellow cells: Delta of LEAPS
- Brown cells: Strikes of LEAPS
Initial trade calculations using LEAPS $35.00 strike with the BCI PMCC Calculator
INTC PMCC Calculations with the BCI PMCC Calculator
Blue cells (top of spreadsheet): Option-chain information entered
Green cells: Key calculation results
- Initial trade formula acceptable with a net credit of $1.20 per share
- Initial 1-month return on short call is 6.85%
- 1-month initial upside potential is 6.65%
- Total maximum 1-month return is 13.50%, 154.02% annualized
Pink cells: Exit strategy buyback points
Discussion
Delta is important with the Poor Man’s Covered Call strategy because we want the security to simulate the price movement of the underlying stock. There are several parameters that must be adhered to achieve the best trade results. The BCI PMCC Calculator is particularly helpful in establishing these trades.
For more information of the PMCC
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Dear Allan;
How do I decide when to close this position ?
I bought XLE @ 40.16 on Nov 24 and sold the Dec 18 calls @ 41 strike for a credit of $1.33 for a cost of 38.83
Today XLE closed at 38.91 down by 3.1%.from 40.16.
If I have a risk tolerance of 3% do I calculate this on the $40.16 or the cost of 38.83?
Thank you
Donna L
Donna,
If you risk-tolerance is 3% per trade, use the $38.83 figure. Give strong consideration to using the 20%/10% guidelines as well, immediately upon entering our trades… $0.27 in this case.
Alan
Premium Members,
This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 11/27/20.
Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
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[email protected]
Hi Alan,
Ever since they started the decimalization, can you still trade between the bid/ask spread in options if its wide enough?
Thanks,
Ysaye
Ysaye,
Yes, and it benefits us to make this a routine part of our trading arsenal. Here is a link to an article I published on this topic:
https://www.thebluecollarinvestor.com/how-to-negotiate-better-option-prices-using-the-show-or-fill-rule-30-rebate-expiring/
Alan
Dear Alan,
I have been watching your videos on covered call trading and will take out a membership.Thank you for taking the time to make these tutorials and sharing your knowledge.
I’m trying to get a handle on the exit strategies. Am I right in thinking that (for swing trading), if the share price goes below our break even point and we’re still bullish on the stock, we can simply sell another OTM call, and that will offset what we have lost in the stock, essentially making us even? Then, in effect, we’re starting our trade again not having lost anything?
If that is correct, and we are strict about this rolling down, our trades are essentially risk free, assuming that the stock bounces back at some point?
Any help is appreciated.Thank you,
Best,
Andrew
Andrew,
There is no question that you are 100% correct that rolling-down to out-of-the-money strikes will be quite helpful in mitigating losses and even turning losses into gains.
That said, there is no such thing as a risk-free trade as it pertains to stocks and stock options. In our BCI methodology, we use low-risk strategies to achieve higher than a risk-free return (Treasuries, for example).
When we roll-down to an OTM strike, we may be locking in a loss on the stock side, while benefitting on the option side.
Early in a contract, we may close the short call and wait to “hit a double” Mastering these exit strategies will set us apart from all other option-sellers and maximize our returns over time.
Your willingness to do your due-diligence and learn these strategies is a sure recipe for success.
Alan
Thank you Alan for your speedy response. I am running some numbers through your calculator and getting a feel for different options and their ROO and downside protection.
Typically, how much downside protection do you prefer? In the current market I can see a case for not needing much but if we sell an at-the-money call, for example, we could very quickly be in a position to roll down. Is that right? Given some volatility is inevitable, do you often find that you have to roll down multiple times for the same stock? And if so, when do you call it quits? A decrease of say, 10% could be a perfectly normal bit of volatility and the trade that is still bullish, but is it expedient to roll down multiple times?
Also, am I correct in thinking that if you typically sell call OTM or ATM, you very often will roll down, meaning you will roll down more often than not?
Best,
Andrew
Andrew,
I start with an initial time-value return goal range (2% – 4% in normal markets for me). We all must know our goals before entering any trades. This applies to ITM, ATM and OTM strikes. For covered call writing, the more defensive I need to be, the closer to 2% I will go with the ITM strikes. That will allow us to meet our stated goals and generate the greatest downside protection. These decisions are based on current market information and personal risk-tolerance.
Rolling-down decisions are based on performance of the underlying, time within the contract and utilizing the 20%/10% guidelines. The frequency of rolling-down is dependent on velocity of stock price decline. Most of the time, we do not roll-down but must take advantage of those opportunities when they present. We never “call it quits” when it comes to position management.
Alan
Good morning Alan,
I hope you’re having a good Thanksgiving weekend!
Regarding your most recent weekly stock report, I had a quick question about your weekly summary under the BCI category.
What does DOTM stand for? I understand you are selling cash secured puts but wasn’t sure what that stands for. Are you avoiding covered calls due to the uncertainty of our current market and the election in limbo?
And it looks like your cash secured puts are weekly and not monthly?
I’m guessing your determining your .10 Delta from the option chain?
Finally, is it better to execute a cash-secured put after a dip or a spike?
I will watch some of your videos and content to refresh my memory.
Thanks in advance for your help. Enjoy your Sunday!
Steve H
Steve,
My responses:
1. DOTM = deep out-of-the-money
2. Yes, using Weeklys because of the market uncertainty we can reassess our bullish assumptions on the underlying more frequently. It’s a bit more time-consuming but meets my defensive current market uncertainty needs.
3. Yes, Delta stats taken from option-chains.
Alan
Allan:
You have me confused. Where does the $1.20 come from in your article? The Bid Price is $1.75 and the short call return is based on the Bid price.
Help.
Thanks in advance.
Marty
Marty,
The option bid price of $1.75 is entered in the blue cells at the top of the spreadsheet.
$1.20 represents the time-value profit based on the initial structuring of this PMCC trade:
[(Difference between the strikes) + (Initial time-value short call premium) – cost of LEAPS option]
[($60.00 – $35.00) + ($1.75) – ($25.55)] = $1.20
This meets our initial trade structuring formula detailed in our book, “Covered Call Writing Alternative Strategies” (pages 117 – 133) and our online DVD PMCC Program.
Alan
Alan:
Thanks for your quick response. Another example of the excellent service from BCI!
Marty
Alan:
When using your basic covered call calculator, it appears that the annualized return for etfs for the weeklies is much greater than the monthlies. Is this true? Am I missing something?
Jerry
Jerry,
Generally, shorter-term option generate greater annualized returns. This is one of several reasons why I avoid long-term short call and short put options.
Alan
Alan,
I have just ordered your exit strategies book. In the mean time is there a blog/resource on the 20%/10% strategy I could read?
Let’s say we enter a trade with 10% downside protection and an ROO of 2%. The trade goes south, and we hit our break even point. Is it then possible to exit the trade at the breakeven point without incurring a loss? If we roll down at that point, are we likely to still make money on the trade or are we aiming to mitigate losses?
I ran the below through the calculator – they seem to be great in terms of the downside protection and ROO. Should I be looking for such high downside protection or is it unnecessary in the current market?
Also, another questions, if you don’t mind. When selecting a trade to take, are you prioritizing the technical set up or the ROO? I ask because there are some fantastic technical set ups on the watch list but they don’t necessarily have the best ROO. Conversely, there are some stocks with great ROO and/or downside protection, but the set ups aren’t as good. Part of me feels that if we manage the trade with rolling down while collecting a nice premium, we don’t need to be so worried about the actual set up because we’re managing the risk should it not turn out right. Is that a sensible way of seeing it.
Grateful for your help, and sorry for the bombardment of questions.
Andrew
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Andrew,
There is no risk-free trade as it pertains to stocks and stock option. In our BCI methodology, we are using low-risk strategies and mastering the 3-required skills to beat the market on a consistent basis.
If we exit a trade at it’s BE, there is a cost-to-close that will put us in a losing trade. Rolling-down will increase time-value profit but also cap stock value which may result in a loss or a gain.
The amount of downside protection we seek is based on overall market assessment and personal risk-tolerance. One size does not fit all. If unsure, go for the minimum time-value return of the stated range and maximum downside protection.
Our watch list of eligible securities includes technical analysis which incorporates trend and momentum. Once that list is established or the ones crafted by the BCI team, ROO determinations are made based on the factors alluded to above.
Here is a link to one of the articles I have published regarding the 20%/10% guidelines:
https://www.thebluecollarinvestor.com/automating-the-20-10-guidelines/
Alan
Hi Alan:
I noticed while reviewing ETFs on IBD that most of them list an EPS date as show in thescreenshot below.
Is this the same as the earnings report date for individual stocks and should we avoid trading when an ETF has an EPS due date within the monthly trading cycle?
Also, with ETF dividends, I am avoiding these during the projected ex-dividend date. Also wanted to verify that this is the correct course of action with ETFs.
I’m enjoying the BCI methodology, have been paper trading for many months, am utilizing portfolio overwriting, and am working to go full-on with covered calls. I am hindered somewhat by the firm I work for – it’s a very large NYC bank that prohibits selling stocks that have been owned for less than 30 days, and not all monthly trading cycles are a full 30 days. Also, while I can deploy the BCI exit strategy of selling the option when necessary within the options trading cycle, I am stuck with the underlying stocks that precipitously decline – not able to sell them off if owned less than 30 days. I’m thinking about a work-around of selling the covered call ahead of the normal trading cycle when needed.
Thank you Alan – and your team – for the help, the useful tool set, and the frequent content in the form of videos, podcasts, and the like.
Fred
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Fred,
This is interesting. Even outstanding and reliable publications like IBD are subject to errors and this appears to be one. ETFs do not have earnings reports. They are baskets of stock with a multiplicity of earnings dates. There is no one earnings date for the security as a whole.
I called IBD for an explanation and neither the rep or his supervisor could explain this. I am waiting for a call from a senior analyst. I will advise if I learn anything.
In the interim, assume no earnings dates for ETFs and avoid ex-dates (for those that generate dividends) if it is critical not to sell the shares.
Alan
Fred,
I received a response from IBD today:
Thank you for contacting Investor’s Business Daily.
You recently contacted our office regarding EPS Due Date information listed for an ETF.
Please be advised the data in question is in fact a system glitch as ETFs do and should not have an EPS Due Date.
Should you require further assistance, please contact IBD Customer Success at 1-800-831-2525 or (310) 448-6600, Mon-Fri, 5:30am-5:00pm Pacific Time.
We appreciate you taking the time to write us.
Michael
Customer Success Rep
Investor’s Business Daily
Investors.com
Dear Alan;
Yesterday I did a covered call transaction on the underlying of FCEL. Bought 100 shares at 10.15. STO an 11 call Dec 18th for 1.67. Today I BTC the option for a 64 dollar profit and paid 1.03 to do so. I then immediately sold my shares of stock for 9.38.
Since my Break even point was 8.48. Did I realize approx.$150 profit from this transaction? Just so I am clear in my head?
Thanks
Kevin
Kevin,
There was a loss of $0.77 per-share on the stock side and a gain of $1.02 per-share on the option side, netting a gain of $0.25 per-share. Using a post-trade cost-basis of $8.48, that results in a 2-day profit of 2.9%.
As an aside, the initial returns for the month was 16.4% making this a highly volatile stock. We must make sure our selections align with our personal risk-tolerance. This trade had favorable results… congratulations.
Alan
If I calculate it right I get a loss of -$0.13 on this trade.
Profit on option side $0.64 ($1.67 – $1.03)
Loss on stock -$0.77 ($9.38 – $10.15)
When I write this FCEL trades at $6.60, down 35% from the original purchase price of $10.15, so Kevin, you are lucky you got out on time 🙂 I think this is a good example that we must be very careful when choosing underlying and avoid volatile stocks.
Sunny
Sunny,
Good catch. I used $64.00 instead of $103.00 for the option debit. The loss is $0.13 per-share.
Alan
Hi Alan,
Hope you’re well sir and down in the Florida sun. Can you field a couple quick questions?
When a stock runs up considerably your book discusses the mid contract unwind. I had a big run up in PLTR so I chose to unwind the position. Then I sold I higher OTM strike. Is that unusual to unwind and then sell a higher strike on a stock that has run up? Do you do that as well or primarily just sell the stock for the gain? Maybe that’s a case by case question.
Also today I was able to BTC a position using the 20% rule. Do you make use of your calculator to find a cumulative potential return? That is, use the roll out and up tab even though it’s the midpoint of the contract?
I guess what I’m asking is there a section of the calculator that I’m missing that would help me determine the roll out and/or out and up at the midpoint of the contract and not just as we approach option Friday? Do we simply use the roll out feature of the what now tab and simply adjust the option dates and ignore that we are not yet near option Friday?
Thank you for your help. I feel that I have a pretty good handle on the concepts I’m just looking to sharpen my skills using all of the exit strategies discussed in your book. Lately I’ve had several ITM positions go further ITM so I’m jus trying to maximize potential returns.
I certainly enjoy the learning process and I’m very grateful for you. My son finally expressed interest in investing! That is very exiting to hear especially since he’s only 18. Hopefully he will finally read your book that I bought for him!
Warm regards and happy holidays,
Patrick
Patrick,
Great news about your son. One of the best gifts a parent can give to a child is the ability to self-invest.
My responses:
1. When we use the “mid-contract unwind” exit strategy we close the short call and sell the stock t6hat has rum up in price. It seems you rolled-up in the same contract month with PLTR. The concern is profit-taking on a stock that has run up in price in a short time-frame. If the time-value cost-to-close approaches $0.00, I will typically close both legs of the trade and use the cash to enter a new covered call trade with a different security selected from our most recent watch list.
2. Yes, we can use the “What Now” tab of the Ellman, Elite and Elite-Plus Calculators for rolling-up in the same contract month.
Alan
The fear index VIX is trying to get back under 20.
Hi Alan,
could you please explain what happened to my covered call trade in AAN ?
I had 400 shares and sold 4 12/18/20 calls last week.
Now, there was a spinoff, and it seems like I ended up with a significant loss. 🙁
Roni
Roni,
There was a spinoff… NO significant loss. I’ll research and post my findings later today…tomorrow at the latest.
Alan
BCI members,
AAN completed a spinoff from PROG Holdings (PRG) yesterday.
For every 1 share of AAN previously owned, 1 share of PRG and 1/2 share of the “new” AAN is owned. The value is about $67.80 as I type.
The new ticker symbol for those who sold options on AAN is now PRG1.
Alan
Thank you, Alan,
I understand and am waiting for this to happen.
So far, my account does not show the 400 PRG shares.
It does show the 4 PRG1 calls at 3.7, and the 200 AAN shares at 18.49.
I guess it takes some time to be processed, but meanwhile, my total account balance is down approx. 15,000.00.
Roni
Roni,
1 (old) AAN = 1PRG + 1/2 (new) AAN
You are not down $15k.
All is well.
Alan
Alan,
thanks again, I have to be more patient.
Roni
Alan,
finally, my money is back, as you said. 🙂
My account balance is back to normal, and it shows 400 shares of PRG trading at 57.34.
My 4 CCs PRG1 strike is 65.00, and I will unwind this position before it drops any further.
Thank you again for your most valuable support during these stressful days.
Roni
Roni,
Does your broker account also show that you own 50 shares of the “new” AAN per contract? You’re probably in a much better position than you think.
Alan
Premium members:
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The mid-week market tone is located on page 1 of the report.
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Alan,
Question about CVS:
11/16/20 With average cost at 74.61 I sold calls on 76 strike calls for $1.00 with 12/11/20 Expiration
11/17 as luck would have it Amazon announced going in to pharmacy sales and CVS,WBA GOOD RX ect dropped like rocks
11/17 Bought Back calls for .20 cents ( following Ellman 20/10 rule).
Then I waited last week and up until now. Drop was so dramatic that CVS today is still only trading 68.80 far below my cost I can only get less than 1% ROO for 12/11 calls.
You say don’t consider profit from past trades in your notes but I don’t want to give back my .80 profit with such unknown on CVS ability to recover. As I see it I have 3 options
1. Follow Ellman rule of writing calls with 12/11/20 expiration which would provide very little. ( Hitting very small double)
2.Wait who knows how long for CVS to continue to rise ( could be dead money for awhile.
3. Write longer dated calls to improve premium slightly but that includes risk that stock will rise and I am hanging around for another month
Your wisdom would be appreciated.
Thank you as always
Steve S
Steve,
I see that CVS is trading at $70.00 pre-market. If we still have confidence in our stock, we can roll-down to an OTM strike, like the $74.00 or $75.00 calls, as examples.
If our bullish assumptions have changed, we sell the stock.
Alan
Steve,
As it turns out, CVS closed today (Friday, 12/4/20) at $74.50. Hopefully, you waited a bit to take advantage of the price recovery.
Best,
Barry
Alan,
I’ve searched the web over and your course is the best I’ve found.
I’ve gone through the beginners guide and will become a member. I would prefer to sell cash secured puts. Which is more desirable for a beginner, covered calls or cash secured puts?
I would like your opinion before I commit myself to study.
Thanks,
Kent
Kent,
Thank you for your kind words.
Start with covered call writing. It is more intuitive than put-selling for beginners. That’s where I started. Once you’ve mastered covered call writing, learning selling cash-secured puts will come easy.
Alan
Hi Alan!!I
I thinking recently in a “exotic” stratetegy, a poor man covered call, but buying the LEAP at Delta 1. In other words, not buy a LEAP in delta .75 or higher, if not only buy LEAP in delta 1.
The reason is leverage: with delta 1, i have the same benefits that in a “normal” covered call (because is delta 1), but i dont have the excessive” “leverage (like when buying in delta .75, very painful when price stock decrease), and, the best notice, this operation is possible with the half price of buying 100 share stocks.
What do you think? I think that is strategy is like a half term into covered call and poor man covered call
Like always, thks for your response!!!
Pablo from Lima
Pablo,
This is a Poor Man’s Covered Call trade whether the Delta is .75 or 1.0. If share price declines, the LEAPS will decline by its Delta, dollar-for-dollar with a Delta of 1.
The deeper in-the-money the LEAPS, the closer the Delta moves to 1.0 and the greater the cost due to the increased intrinsic-value of the premium.
When using the PMCC strategy, Deltas between .75 and 1.0 are acceptable. It is important to master all the moving parts of this strategy before making a long-term commitment. It is much more than “covered call writing, but cheaper”
Alan
Hi Alan,
When you’re in a trade and the stock has gone against you to the breakeven level price, do you sell the stock at that time but hold the option to expiration?
If not what would be your strategy at that point?
Thanks,
Gerry
Gerry,
If we sell the stock and leave the short call, we are in a risky naked option position. This will require a much higher level of trading approval most retail investors will not be granted.
We use the 20%/10% guidelines to assist us in when to close the short call and then decide on the next step… rolling-down, “hitting a double”, selling the stock etc.
Alan
Hi Alan,
My father, who’s from Rockville Centre, has been using your strategies over the past five years with great success. He introduced me to your method last summer, It has been a wonderful experience. I have been making about 2%/month since I started with 29% returns in the last 12 months! I’m a believer.
Here’s my question: Is there a strategy where you sell a call that expires two weeks after an in the money cash-covered put you’ve already sold? In essence you are selling a “stock-covered” call in advance of a stock you don’t own, but will very likely own.
Here’s the specific scenario:
On 12/1/20 I sold 10 contracts of the following cash covered put: WKHS201211P22 with a premium of $0.81/share. This has a 3.68% 10-day return.
The price of the stock has dropped 20% from $25 to $20 as of today, so I think it is likely the option will be assigned.
Normally I would wait for the stock to be assigned and then I would sell a stock covered call for the next month.
What if I sell a naked call now for the end of the month at the same strike price (WKHS201231C22)? I could get a premium of $2/share
Risk scenarios:
1. Stock goes above 22 prior to 12/11 then I’m on the hook for potential unlimited risk. I have some upside protection and start losing money above $22 + $2 + $0.81 = $24.81 (52 week high is $30 and it’s going down)
2. Stock goes above 22 after 12/11 and stays above 22 on 12/31. The put is assigned and then the call is assigned on 12/31. Profit maximum is just the premiums ($2,810). This is a 12.8% 21 day return.
3. Stock stays at 20 or lower: Put is assigned (12/11/20) and Call expires worthless on 12/31. I get downside protection and lose money at $22 – $2 – 0.81 = $19.19. I can then sell a call for the next month.
Is there a formal name for this? Seems like it has real potential……
Best,
Jason
Jason,
I’m so pleased to learn of your family’s success using the BCI methodology.
I am not a big fan of naked option trading (to say the least).
Using this approach will require a higher level of trading approval, difficult for retail investors to achieve. Most shouldn’t have this level of trading approval… there are exceptions.
What if the stock price moves up dramatically? The put strike will move out-of-the-money and expire worthless. We are now faced with the contract obligation to provide the shares at the call strike which can be much lower than current market value.
Why convert low-risk strategies to high-risk strategies? Appropriate for some, but not for most.
Alan
Hi Alan,
Does rising VOLQ means the higher options premiums for QQQ too?
Sunny
Sunny,
Yes. VOLQ measures the implied volatility of the Nasdaq-100 Index (NDX). QQQ is the ETF equivalent of NDX. Our option premiums for QQQ will rise as VOLQ rises.
Alan
Hi Alan,
Hope you are having a safe and festive holiday season so far !!
I ordered your book on pmcc’s (poor mans covered calls) and can’t understand for the life of me why it hasn’t already arrived having just ordered it less that 24 hours ago ! 😉 Just kidding.
Since I have not been able to read the book yet, I am wondering what the overall idea is with pmcc. That is to say, where do I look to make more money. Is it on the long side with the far out long call or more on the short side with the covered call?
Also, is the idea here to stay out of the money with the short side (covered call) and sell many months of covered calls or to make a bit more money and sell them closer to ITM?
And know that usually when my short call goes ITM on covered calls. I do like the movie, and just let it go. I am fine with taking the profits and look to sell a cash secured put.
Like always, thanks for your response!!!
Beef
Beef,
I’ll check with the post office to see about this unacceptable delay.
My responses:
1. There are many aspects to the PMCC strategy all detailed in “Covered Call Writing Alternative Strategies” so this response is a brief overview: LEAPS options are cheaper than stocks so the cost-basis is lower and therefore the return on investment is higher. If we make $1.00 on a $100.00 investment, that’s a 1% return. If we make $1.00 on a $10.00 investment, that’s a 10% return.
2. The short call is OTM and the specific strike selected is based on our initial time-value return goal range which should be defined before entering any trade. For me, it’s 2% – 4% per month and up to 6% in strong bull markets. This is for traditional covered call writing and put-selling. It would be higher for PMCC.
3. If the short call is ITM as expiration, we can roll the option or allow assignment. That plan should be established prior to entering the trade.
Now, let me make that call to the PO.
Alan