Poor man’s Covered Call: All You Need To Know

Poor man's Covered Call
Poor man’s Covered Call

Poor Man’s Covered Call are a popular way to generate income from best stocks options, but they require an initial investment in the underlying stock, which can be substantial. While such an investment isn’t a problem for those with large accounts, it can be prohibitively expensive for those who are just starting out with options to generate income. Fortunately, there are some alternative strategies that investors can employ in order to generate income from options. Let’s look at an example of a popular Robinhood Best Stocks poor man’s covered call that doesn’t require an upfront investment in the underlying stock.

What Is a Poor man’s Covered Call?

Buying a longer-dated, in-the-money call option and writing a shorter-dated, out-of-the-money call option against it constitutes a poor man’s covered call (PMCC). It’s technically a spread, which can be less risky and more complex than a true covered call. This isn’t the most intuitive strategy, but it’s worth learning about if only to broaden your options.

Why does this Work?

Consider shares to option with an infinite time to expiration and a delta of one. In other words, for every $1.00 change in the underlying, their price would move to $1.00. (I know it’s circular because they’re underlying, but this concept is crucial.)

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Consider standard covered calls to be the use of -DTE, 1.00-delta “options” (i.e., shares) as collateral. Because of these characteristics, the “options” are costly. However, if we replace those shares with actual options, which have an expiration date and a lower delta, our collateral becomes much cheaper!

This increases risk, as we’ll see, but first consider why the PMCC might file an appeal in the first place.

Trading Stocks

First, we’ll go over stock trading. For Poor Man’s Covered Call example, I’ll use Boeing (BA) as the stock on which I’m bullish. If you were a stock trader, you’d probably buy a lot of stock. To keep things simple, we’ll use a position of 100 shares in this example.

Boeing’s stock has had a difficult year, and it is currently trading at around $130 per share. If you bought 100 shares of Boeing, you’d be out $13,000 in purchasing power.

Let’s start with the basics: if Boeing’s stock price rises by $10 to $140, you will profit by $1,000. We can think of this as putting $13,000 at risk to earn $1,000. This is all basic stuff, and you’re probably already aware of it.

Selling Covered Calls

Let’s stick with Boeing as our Poor Man’s Covered Call example for the time being. Assume you expect Boeing’s stock price to rise in the short term, which explains why you are bullish on the stock. We can easily sell covered calls on our position because you already own 100 shares of Boeing stock. Let’s take a look at Boeing’s $150 Call Option.

If Boeing’s stock price rises to $140 as expected, we’ll earn an extra $450 in premium by selling our covered calls. This is on top of the $1,000 you would have earned from your underlying position. If the stock price falls, the covered call will act as a hedge.

In this case, if Boeing’s stock fell to $120, you would lose $1,000 on your initial investment. However, because we sold the $200 Call Options contract and kept the $450 premium, our net loss is only $550.

Poor man’s Covered Call Robinhood

Poor man’s Covered Call Robinhood will typically sell your long call in order to offset the cost of your short call expiring in the money. If you simply let the short call be assigned, you will be obligated to purchase 100 shares at the strike price you specify. Poor man’s Covered Call Robinhood will liquidate positions to cover this purchase if the funds are not in your account, either in cash or on margin.

Step-by-step of How to Sell Poor man’s Covered Call on Robinhood

Step 1

Look for a stock on which you want to buy an in-the-money long call in your portfolio. Look for a high-quality company in which you have faith. For this example, I’ll use Disney (DIS). It is a large, stable company that expands its operations year after year. Begin by clicking the “Trade” button.

Step 2

After you click the “Trade” button, a menu will appear. You have the option of selecting “Trade Options” or “Buy.” Choose “Trade Options.”

Step 3

You will then see a screen similar to the one shown on the right. To begin, ensure that both “Buy” and “Call” are selected. Next, adjust the expiration dates at the top of the screen until they are at least 3 months in the future.

Step 4

Next, look for a strike price that is deep in the money and has a delta of at least 0.70. If you tap the option’s text ($130 Call), you’ll see a screen similar to the one shown to the right.

In this example, DIS is currently trading at $149.30. I’m going to purchase a call with a strike price of $130 and an expiration date of 1/20/23. The delta for this option is 0.74. This meets all three criteria for our lengthy call.

Step 5

If you decide that the option you’re looking at is the one you want, click the “+” button. The options button highlight and the + button will both change to a checkmark.

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I’ve chosen the call with a strike price of $130. The highlighted button has “$30.90” written on it. That means I can expect to pay around $3,090 for this long call. This is significantly less than the $14,930 it would cost me to buy 100 shares.

Step 6

We’ll then look for your short call. Make certain that the “Sell” and “Call” buttons are selected. You want to find an option that has an expiration date before your long call. You also want to find a strike that you are confident will expire out-of-the-money. Select the “+” button next to the option you want to be your short call once you’ve found it. Now go to the bottom of the screen and select “2 Options Selected.”

Step 7

You will now see a screen similar to the one shown to the right. You can now review all of your PMCC’s details as well as a P/L Chart. When you’re satisfied with everything, click the “Review” button. On the following screen, you can choose to execute the option. Congratulations on participating in your first PMCC. You can continue to sell short calls against your long call as the short calls expire until the long call expires. Each short call that you sell reduces the cost basis of your long call.

How Should Stocks for a Poor Man’s Covered Call Be Selected?

Likelihood of a price change:

If the stock price falls, you will suffer the same consequences as if you were holding any other type of investment.

The premium from the calls you sold, as well as the dividends you received, more than compensate for the pain of a price drop, making this a win-win situation for everyone involved.

The premium and dividends take a long time to compensate for a stock that drops by 25% in a matter of weeks due to a missed quarterly earnings announcement.

Volatility:

If your stock is a steady Eddie, which means it is stable, the price of a covered call falls. Investors are less willing to pay you for the opportunity to own shares in a company if the stock price is flat or declining.

When stock prices fluctuate, you may be able to profit from selling covered calls, but you may also increase your risk of losing the stock. It means you should sell the calls and wait for them to lose value before repeating the process with new calls to sell.

Don’t invest in stocks with high dividend returns:

While the high dividend yields of this strategy are appealing, you will quickly discover that selling covered calls is where you will make the most money the vast majority of the time.

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Stocks that pay out large dividends could be the result of a variety of factors, such as a significant drop in their price or the fact that they are safe dividend-paying companies with minor price fluctuations.

The investment provides a return on investment:

A call option buyer has the right, but not the obligation, to purchase the underlying stock at the strike price determined by the option’s seller.

These events may be caused by the procedure in question in some cases. If, on the other hand, you decide to sell the stock, the profit will be subject to capital gains tax.

Best Stocks for a Poor Man’s Covered Call

#1. Oracle (ORCL)

Oracle’s six-month chart only showed a significant drop to the $40 range in March. It made few headlines in the computer technology industry, which continued to function normally. Oracle could be a viable option for a low-cost covered call.

#2. PepsiCo (PEP)

PepsiCo, a well-known food and beverage corporation, is one of the world’s largest. The company manufactures, promotes, and sells a wide variety of beverages and snacks. In some cases, the company uses third-party bottlers, contract manufacturers, and distributors, but its overall go-to-market strategy is consistent.

#3. Walmart (WMT)

COVID was making a lot of people sick. Walmart demonstrated its ability to withstand the epidemic as well as Amazon’s near-complete control of almost every other retail sector. Walmart’s stock price never fell below the triple digits prior to the $100 mark, making covered call positions lucrative.

Conclusion

The best stocks for a poor man’s covered call are one of the most popular ways to make money. This is despite the fact that the technique has low risk but a high upfront cost, which varies depending on the price of the stock.

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Long-term investors may not be concerned about using covered calls as a source of income, but short-term investors may want to look into other options.

Trading a Poor Man’s Covered Call is a great alternative to actually trading a covered call. This method can be used to simulate a covered call position in smaller accounts with less cash and less risk.

To deliver the shares to the shareholder in the case of a covered call, a long in-the-money call option is used instead of a long stock position. Because of the lower cost of entry, smaller accounts can generate revenue while potentially taking advantage of lower-risk opportunities.

Frequently Asked Questions

How much can you make on poor mans covered calls?

They’ll change by the time you see it, but the percentages should be close.) The collateral for a traditional covered call is $172.07 * 100 = $17,207. If the short call expires worthless, the collateral returns will be $356 / $17,207 = 2.1 percent. A PMCC against a 9-month call with a delta of 0.90 ($120 exp).

How do you roll a poor man's covered call?

Rolling a PCMM down and out is done when a trader wants to significantly reduce the cost basis of a long call or has changed their mind about the stock’s price. This is accomplished by simultaneously: Purchasing the original short call. Selling a call option with a lower strike price and a longer expiration date.

Are poor man's covered calls worth it?

A poor man’s covered call is an excellent substitute for trading a covered call. In smaller accounts, this position can be used to simulate a covered call position with significantly less capital and risk than a traditional covered call. The configuration of a poor man’s covered call is critical.

How do you lose money selling covered calls?

The covered call strategy is fraught with two dangers. The genuine danger of losing money if the stock price falls below the breakeven point. The breakeven point is the stock’s purchase price less the option premium received. There is a significant risk associated with any strategy that involves stock ownership.

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