The Significance of Breakeven When Constructing Our Poor Man’s Covered Call (PMCC) Trades: A Real-Life Example with International Business Machines Corp. (NYSE: IBM)

The PMCC Strategy involves buying LEAPS call options (expirations 1 – 2 years out) and selling short-term call options against the long position. The technical term is a long call diagonal debit spread. In our BCI methodology, the trade construction must meet a required trade initialization formula where the difference between the 2 strikes + the initial short call premium must be greater than the cost of the LEAPS option. Adhering to this formula will allow us to close a PMCC trade at a profit if share price rises exponentially and we are forced to close the trade. Another calculation that can be made when setting up these trades is the breakeven (BE) price point. This article will highlight the significance of BE as calculated by the BCI PMCC Calculator.

Real-life example with IBM

• 6/6/2022: IBM trading at $141.35
• 6/6/2022: The January 19, 2024, $120.00 LEAPS shows an ask price of $29.15
• 6/6/2022: 7/15/2022, $150.00 call shows a bid price of $1.04

Calculations using the BCI PMCC Calculator

IBM: PMCC Calculations

Note the following:

• The initial trade structuring successfully meets our required formula (noted with a bold “YES”) with a positive $1.89 per-share should the trade be closed early due to significant share appreciation. In other words, the trade would be closed at a profit in that scenario
• The 39-day short call return is 3.57%, 311.11% annualized
• There is additional upside potential, if IBM moves up the $150.00 strike of 29.67%
• The total 39-day potential return is 33.24%
• The breakeven price point is $148.11, higher than current market value
• What is the significance of this BE price point?

How we calculate the PMCC BE price point to be $148.11?

• Buy IBM at $120.00 and sell at $148.11 = +28.11
• The cost of the LEAPS is $29.15, less the $1.04 initial short call premium = $-28.11
• This does NOT mean that IBM must move to $148.11 in order to be a successful trade
• It does mean that if we close the trade, IBM must be above $148.11 (at that point in time) to be profitable

Practical application of the PMCC BE price point in this IBM example

If IBM trades at $148.11 at expiration, with a $150.00 strike in place, no action would be taken, and we would realize a significant 39-day return. With this share appreciation in mind, we would write a higher strike call in the next contract cycle to continue the cash generation process.

Discussion

When structuring our PMCC trades, the BE price point represents the share price where credits and debits equal zero should the trade be closed. The price of the underlying security can be lower than the BE price point at expiration and still result in a highly successful ongoing trade.

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 Covered call writing is a low-risk option-selling strategy geared to generating cash-flow with capital preservation as a key requirement. This presentation will demonstrate how the strategy can be crafted to succeed in all market environments.

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