The Poor Man’s Covered Call is a covered call writing-like strategy where a LEAPS option is used as a surrogate for the actual stock or exchange-traded fund (ETF). When structuring our PMCC trades, we must make sure it aligns with our required initial structuring formula. This will allow us to close our PMCC trades at a profit if the share price rises exponentially and we are forced to close both legs of the trade.
Why would we be forced to close both legs of the PMCC trade if share price moves significantly higher?
If stock or ETF price rises well above the short call strike, we would be required to pay a high intrinsic-value component to buy back the short call to avoid exercise and roll the option. We may not have the capital or the motivation to add significant resources to this trade and opt to close, preferably at a profit.
PMCC required trade initialization formula (Inherent in the BCI PMCC Calculator)
[(Difference between the 2 strikes) + initial short call premium] > Cost of LEAPS option
Factors that influence the appropriateness of our initial trade structuring
- LEAPS have wider bid-ask spreads than near-the-money short calls and this must be overcome
- Deeper in-the-money (ITM) LEAPS strikes have lower time-value components to the premiums than those closer to the current market value
- The BCI PMCC Calculator will show a “YES” or a “NO” to reflect if the trade entries are appropriate for initial trade structuring
- If “NO”, use a deeper ITM strike until a “YES” is posted
Real-life example with Walgreen Boots Alliance Inc. (Nasdaq: WBA: $40.01): Short call option-chain
WBA: Short Call Option-Chain
Real-life example with WBA: 1/17/2025 LEAPS option-chain showing $35.00 and $27.50 strikes
WBA: LEAPS Option-Chain
If we do the math, we will calculate the time-value component of the $35.00 strike to be $4.84 and that of the $27.50 strike to be $2.04, confirming that deeper ITM strikes have smaller time-value components.
PMCC calculations with the $35.00 LEAPS strike: “NO”
WBA: Inappropriate PMCC Initial Structuring
If forced to close this trade, it will be at a loss of $1.98 per-share (red arrow).
PMCC calculations with the $27.50 LEAPS strike: “YES”
PMCC: Approved WBA Trade
If forced to close this trade, it will be at a profit of $0.82 per-share (red arrow).
Discussion
When establishing our PMCC trades, we must adhere to the BCI initial structuring formula. Bid-ask spreads and time-value components of our premiums play major roles in these decisions. If the trade is deemed not appropriate, we look to deeper ITM LEAPS strikes with lower time-value components (also, greater intrinsic-value costs). The BCI PMCC Calculator will do all the mathematical legwork for us.
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Hello Alan.
Please give me feedback regarding the early contract strategy:
4/10. Bought 600 shares ELF at 83.45
4/10 Sto 6 lots expir 5/19 strike 85 @3.70
4/20. Btc 6 lots @11.90
4/20 sto 6 lots expir 5/19 strike 95 @ 4.6
4/20 Elf stock about 95.2 at the time.
Thank you.
Barry
Barry,
Congratulations on a successful trade to this point.
I the BCI methodology, we rarely roll-up a covered call trade mid-contract. Our concern is that profit-taking on a stock that has accelerated in price substantially in a short time frame, which may convert a winning trade into a losing one. Instead, we evaluate the mid-contract unwind (MCU) exit strategy.
Let’s review these trades:
The initial time-value return for this 40-day trade is 4.43% with another 1.86% in upside potential. This represents a max return (w/o exit strategies) of 6.29%.
On 4/20, the trade status was this unrealized max return of 6.29% with protection of this max return from the current market value of ELF $95.20 to the $85.00 strike. What a great position to be in!
I admire your rationale to generate an additional income stream.
Rolling-up in the same contract cycle will result in another 3.18% IF share price remains above the new $95.00 strike. If there is profit-taking (a definite possibility), we are at risk. I would consider this a risky approach that may work out.
My preference would be to evaluate MCU (close both legs of the ELF trades and enter a new covered call trade with a different security, if the time-value cost-to-close approaches zero). This will lock in most of the ELF trade profit and allow for a 2nd potential income stream with a similar cash investment.
Of the $11.90 cost-to-close, $1.70 or 2% is time-value. We ask ourselves if we can generate at least 1% more (>3%) with a new security and a new covered call trade by 5/19.
Based on this data, my personal approach would be to take no action at this time and continue to monitor the trade as initially established but checking on MCU from time to time.
Keep up the good work.
Alan
Alan
Thanks so much for your insight. My problem is I am doing so well I am tempted to quit my day job!
Barry
Alan,
In your response to Barry, you say “This will lock in most of the ELF trade profit and allow for a 2nd potential income stream with a similar cash investment”.
Why isn’t it the exact same cash investment?
Thanks a lot.
Michael
Michael,
When we buy-to-close the original trade, we add additional cash to the trade in the form of intrinsic-value, so the overall investment is a bit higher.
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 04/21/23.
Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them on The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
https://www.youtube.com/user/BlueCollarInvestor
Reminder: Premium members are grandfathered into your current rate and will never see a rate increase as long as the membership remains active.
Please note that the Weekly Report for 04/28/23 will be uploaded on 04/27/23.
Best,
Barry and The Blue Collar Investor Team
barry@thebluecollarinvestor.com
Allan,
Last few weeks report is, well just down right profitable. Your market sentiment blurb and all the little nuances of the BLUE COLLAR REPORT save me hours
CEO strategy ETF’s ratings were perfect, made premiums + some stock appreciation, and let some get assigned so I can start all over this week.
Thanks .
Sing it from rooftops in Poconos … Became a premium member.
Big profits so far April , since your report I have increased my already great covered call income by 25% at least.
PS
SGOL made a great return and just missed getting assigned and I can sell outright for small profit or write some calls …
Allan I love what you do for us. I’m a broken record , but thanks , thanks thanks……..
John
John,
You made my day! Thanks so much.
Continued success,
Alan
Dear Alan and Barry:
I’m a BCI member and I have a question and need some guidance. Please help me out.
I would like to invest part of my money in a very conservative income strategy using selling deep in the Money Covered Calls with ETFs. I have seen that you can a achieve a 0.8% to 1.2% return on time value with a lot of downside protection. The idea of this strategy is to hopefully never lose money, using exit strategies and managing the position if necessary.
For example, at the moment, the MAY 19 QQQ covered call would yield a return of 1% with a downside protection of 5.8%. My question is regarding manage the position in the following scenario.
10 days or so into the trade, the market tanks and QQQ drops around 5%. Things are looking grim and the market could keep falling. The downside protection has been greatly reduced and there is risk the trade will become unprofitable if the market keeps falling.
What action would you recommend to roll the option and have more downside cushion and still earn a profit due to obtaining more premium due to time value. I’m confused since in this scenario, QQQ dropped so much, the originally deep ITM call I sold is now near the money and thus its time value will probably be higher than at the moment I sold it despite being 10 days into the trade. I can’t buy it back and sell a deep ITM call in the same expiration period because its time value will be much lower and thus it will create a loss. The only solution I see is to sell a deep ITM call with further expiration, so its time value premium would be greater than the now near the money call I originally sold, but this will probably reduce the return of the trade lower than the intended 1%.
I hope you can give some guidance in this scenario and or share your experience if you have invested with a similar strategy.
Thanks and best regards,
Victor
Victor,
This is a reasonable defensive approach to covered call writing with 1 important caveat: There is no such thing as a “never lose money” strategy that seeks to generate greater than a risk-free return.
Our goal should be to structure our trades such that there will be many more winners than losers.
To your hypothetical:
1. After entering our covered call trades, always enter our 20%/10% buy-to-close, Good-until-cancelled limit orders. This will allow us to automate closing our short calls when share price declines substantially.
2. At this point, we have several choices:
a. Roll-down to an OTM strike which will result in a time-value credit (could also be ATM).
b. Take no action, in hopes of re-selling the original option (hitting a double).
c. Selling QQQ (if grossly under-performing the S&P 500 or dropping >7% from when trade was entered).
3. We generally avoid rolling out-and-down, thereby extending an already losing trade.
To master all exit strategies, consider this book:
https://thebluecollarinvestor.com/minimembership/softcover-exit-strategies-for-covered-call-writing-and-selling-cash-secured-puts/
Alan
I am a recent subscriber to the CEO pkg.
My question addresses Volume & Open Interest in the decision to buy or sell ETF options per the CEO strategy. It seems that most ETF options have very low V & OI.
My understanding is that a reasonable level for these two data should be Volume, more than 500, and Open Interest, more than 100.
Could you refer me to an analysis for these factors as they apply to the CEO program. I have consulted Alan’s CEO CC book but cannot locate any reference.
Jim
Jim,
The BCI guideline for option liquidity is 100 contracts or more of open interest (OI) and/or a bid-ask spread of $0.30 or less. Since the Select Sector SPDRs are popular ETFs, this is almost never an issue.
Our preference is to focus in on OI rather than Volume since Vol is re-set to 0 every day, whereas OI is total # of contracts outstanding.
The best time of the day to check option liquidity is after the market opens and market-makers have time to assess market direction. I execute my initial trades between 11 AM ET and 3 PM ET, which also avoids early morning and late afternoon computerized institutional trading.
Alan
Premium members:
This week’s 4-page report of top-performing ETFs has been uploaded to your premium site. The Select Sector SPDR section is now crafted to align with our streamlined (CEO) approach to covered call writing. The report also lists Top-performing ETFs with Weekly options, mid-week market tone as well as the implied volatility of all eligible candidates.
Premium member video link:
https://youtu.be/EXMO-KwZuJs
For your convenience, here is the link to login to the premium site:
https://www.thebluecollarinvestor.com/member/login.php
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https://www.thebluecollarinvestor.com/membership.shtml
Alan and the BCI team
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 04/27/23.
Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them on The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
https://www.youtube.com/user/BlueCollarInvestor
Reminder: Premium members are grandfathered into your current rate and will never see a rate increase as long as the membership remains active.
Best,
Barry and The Blue Collar Investor Team
barry@thebluecollarinvestor.com