"Buy the dream of infinite upside, and collect the reality of consistent income."


— S. Erasmus

Introduction

The Poor Man's Covered Call (PMCC) is a powerful diagonal options strategy. It uses a long-term call as a proxy for owning the stock, allowing traders to benefit from reduced capital requirements while still capturing upside potential and generating income by selling shorter-term call options. This lesson unpacks the strategy, focusing on execution, timing, and risk management.

Understanding the Poor Man’s Covered Call

• Definition: The PMCC involves purchasing a deep in-the-money (ITM) long-term call option (often a LEAP) and selling a shorter-term call option against it.
• Why It’s “Poor”: This strategy mimics a traditional covered call without requiring full stock ownership, reducing the capital needed.
• Leverage and Risk: The LEAP acts as a highly leveraged substitute for the stock, with reduced exposure to large capital losses.

Visualizing the Strategy

• Banner Image Insights:
  • A covered figure on a call symbolizes the essence of "covered calls."
  • A mechanism with levers hints at leveraging options for optimized returns.
  • Imagery of "hard times" juxtaposed with available capital captures the cost-effectiveness of this approach.

Execution and Timing Principles

Optimal Market Conditions for Selling Calls

• Avoid Selling During Breakouts: When a stock breaks resistance or shows strong upward momentum, hold off on selling calls. Let the LEAP benefit from the run.
• Sell Calls in Flat or Stalling Markets: Capture premium when the stock shows signs of stalling.

Win-Win Positioning

• Maintain one unburdened contract:
  • This ensures unlimited upside potential if the stock surges unexpectedly.
• Use remaining contracts for weekly or monthly call sales:
  • Generates consistent income while mitigating risk.

Risk Management Rules

Rule #1: Embrace Imperfect Timing

• No one can perfectly time the market. Adjust positions to protect against poor timing.

Rule #2: Don’t Exercise the LEAP

• Avoid surrendering extrinsic value. Always close the short-term call by buying it back instead of exercising the long call.

Rule #3: Have a Plan for Adverse Moves

• Stock Drops: The sold call expires worthless, earning income to offset the decline in the LEAP’s value.
• Stock Surges:
  • Let the short strike be exercised if you’re prepared to short the stock at the strike price.
  • Ensure you have sufficient capital (typically 150% of the short value) to cover this position.

Mental Stop Loss

• Example: For a LEAP on a stock trading at $26, set a mental stop loss at $16.50. Exit the position if the stock declines significantly to avoid further losses.

5. Practical Tips and Final Thoughts

• Start small: Test with one or two contracts to refine your strategy and timing.
• Keep a portion of your position unburdened: Ensures flexibility and avoids frustration from mistiming.
• Always evaluate premium potential: Select strikes with attractive premiums but manageable risk.
• Avoid emotional decision-making: Stick to predefined rules to reduce stress and ensure consistency.

Conclusion and Next Steps

The PMCC is a nuanced strategy that blends leverage and income generation. By mastering timing, risk management, and contract allocation, traders can maximize returns while minimizing downsides. In the next topic, we’ll explore what happens if you end up short on a stock and how to manage that scenario effectively.

As an additional resource, there is a video covering this entire topic which may include some additional content. Click below to view it.