Last updated on: 2023/11/28
Covered Call is a popular way to improve returns on long term investments. But selling Covered Calls requires a lot of buying power to execute, so there's something called a Poor Man's Covered Call strategy to help you make similar returns using less capital investment.
Today SlashTraders will show you how to execute Covered Calls with less buying power.
Contents
- What Is a Covered Call?
- What Is a Poor Man’s Covered Call?
- Differences Between Poor Man’s Covered Call and a Normal Covered Call
- How to Find the Best Poor Man’s Covered Calls to Enter
What Is a Covered Call?
A common Covered Call works by holding 100 stocks while selling an OTM Call options that expires next month to increase the returns on the buy and hold strategy.
When we invest in BABA with the Covered Call options strategy, the trade uses $8,495 in buying power:
- Buy 100 stocks.
- Sell a 0.20 delta OTM Call option at $110 that expires next month.
The trade can earn the short Call premium of $231 if the stock price doesn't rise beyond $110 before expiration. If the stock price rises beyond $110, the maximum profit on the Covered Call is $2,405.
If we don't want to spend so much cash on a single trade, we can use the Poor Man's Covered Call to achieve a similar result.
What Is a Poor Man’s Covered Call?
Poor Man's Covered Call is an options strategy that combines a long deep ITM long-term Call and a short OTM Call option.
A Poor Man's Covered Call on BABA uses only $3,825 in buying power, less than half of the Covered Call:
- A 0.90 delta long Call at $50 that expires 5 months later.
- A short 0.20 delta OTM Call at $110 that expires next month.
If the stock prices doesn't rise beyond $110 before expiration, we profit $231 from the short Call premium. If the stock price goes up beyond $110, the maximum profit from the Poor Man's Covered Call is $2,175.
However, if the stock price drops below $50 within 5 months, the value of the options strategy becomes worthless.
Differences Between Poor Man’s Covered Call and a Normal Covered Call
The advantage of a Poor Man's Covered Call is to earn similar profits with less capital investment.
From the BABA example we showed earlier, the Poor Man's Covered Call uses less than half of the buying power to earn the same short Call premium.
| Strategies | Buying power | Short Call premium (%) | Maximum profit (%) |
|---|---|---|---|
| Covered Call | $8,595 | $231 (2.7%) | $2,405 (28%) |
| Poor Man's Covered Call | $3,825 | $231 (6.0%) | $2,175 (57%) |
If the stock price shoots up, the Poor Man's Covered Call gives us a higher Return on Capital.
But if the stock price falls unexpectedly, the Covered Call trader can patiently wait for the stock to rebound in the future. On the other hand, the Poor Man's Covered Call trade needs to close before the options expire, giving us less time to respond when the market goes down.
How to Find the Best Poor Man’s Covered Calls to Enter
We choose Poor Man's Covered Call opportunities like we do with the popular version, by finding blue-chip stocks that we want to invest in long term.
The Bullish Value Stocks list shows us undervalued, blue-chip stocks that have a high probability of going up.
We can see PayPal is heavily undervalued right now.Compared to Fair Value from the fundamental analysis, there is 123% of potential Upside.
The technical analysis also tells us PYPL has a bullish signal 1 trading day ago, shown by the Long Signal Days of 1.
A Poor Man's Covered Call on PYPL costs $3,430 in buying power:
- Buy a 0.90 delta ITM Call option at $45 that expires 5 months later.
- Sell a 0.20 delta Call option at $95 that expires next month.
We can make $133 from the short Call premium if the stock prices doesn't reach $95 by next month. If the stock prices goes beyond $95, the maximum profit from the trade is $1,570.
Even though a normal Covered Call is a low risk options strategy that boosts returns on long term investment, but it requires a great capital investment. We can use Bullish Value Stocks to find Poor Man's Covered Call opportunities to reduce the buying power by half to earn the same potential profits.
Trending Articles
As an enthusiast well-versed in options trading strategies, particularly covered calls and poor man's covered calls, let me dive into the concepts discussed in the provided article.
1. Covered Call: A covered call is an options trading strategy that involves holding a long position in a stock and selling a call option on that same stock. The goal is to generate income from the premiums collected by selling the call option. In the context of the article, the covered call is explained using the example of buying 100 stocks and selling an out-of-the-money (OTM) call option with a specific strike price and expiration date.
2. Poor Man’s Covered Call: The poor man's covered call is a variation of the traditional covered call strategy. It involves buying a deep in-the-money (ITM) long-term call option while simultaneously selling an OTM call option. This strategy aims to replicate the profit potential of a covered call but with a significantly reduced capital investment. The article illustrates this with an example, comparing the buying power and potential profits of a normal covered call versus a poor man's covered call.
3. Differences Between Poor Man’s Covered Call and a Normal Covered Call: The primary difference lies in the capital requirement. A poor man's covered call allows traders to achieve similar profits to a traditional covered call with a substantially lower buying power. The article provides a comparative analysis of buying power, short call premium percentage, and maximum profit percentage for both strategies using an example with BABA stock.
4. Strategies - Buying Power, Short Call Premium, Maximum Profit: The table in the article summarizes the key metrics for both covered call and poor man's covered call strategies, showcasing the reduced buying power and potentially higher returns of the latter. It emphasizes the advantages of the poor man's covered call in terms of return on capital, especially if the stock price rises.
5. How to Find the Best Poor Man’s Covered Calls to Enter: The article suggests selecting poor man's covered call opportunities in a manner similar to traditional covered calls. Traders are advised to look for undervalued blue-chip stocks with potential upside. The example of PYPL is given, demonstrating how to identify undervalued stocks using fundamental and technical analyses. The poor man's covered call on PYPL is then detailed, including the buying power, strike prices, and potential profits.
In conclusion, the article provides a comprehensive guide to covered calls, introduces the concept of poor man's covered calls as a capital-efficient alternative, and offers practical insights into finding suitable opportunities using fundamental and technical analyses. This information is valuable for investors looking to optimize returns while managing capital effectively in the options market.
