What Is a Poor Man’s Covered Call?

A “Poor Man’s Covered Call,” often referred to as a PMCC, is an options trading strategy designed to replicate a traditional covered call with significantly lower capital investment. This strategy utilizes a combination of options contracts to achieve similar exposure to an underlying asset without requiring the purchase of 100 shares of stock directly. The “poor man’s” moniker highlights its capital efficiency, making it accessible to individuals who may not have sufficient funds to buy a large block of shares. It aims to generate income through premium collection while maintaining a bullish or neutral outlook on the underlying asset.

Understanding the Traditional Covered Call

A traditional covered call strategy involves owning at least 100 shares of a particular stock and simultaneously selling one call option contract against those shares. Each standard options contract represents 100 shares of the underlying security. The primary objective of this strategy is to generate income from the premium received when selling the call option. This premium helps to offset the cost basis of the stock position or simply adds to overall portfolio returns.

The strategy is termed “covered” because the investor already owns the underlying shares, which act as collateral for the sold call option. If the stock price rises above the strike price of the sold call option, the shares can be delivered to fulfill the obligation, effectively limiting the upside profit potential to the strike price plus the premium received. This strategy requires a substantial upfront capital outlay to purchase the 100 shares of stock, which can be a barrier for some investors. While it provides a limited hedge against a decline in the stock price, the investor still faces significant downside risk if the stock falls sharply beyond the premium collected.

Components of a Poor Man’s Covered Call

The Poor Man’s Covered Call strategy is constructed using two distinct options contracts that work in tandem to mimic a traditional covered call. The first component is a long-term equity anticiPation securities (LEAPS) call option. LEAPS are options contracts with expiration dates extending significantly further into the future than standard options, typically one to three years out.

For the PMCC, a deep in-the-money (ITM) LEAPS call is purchased. This means its strike price is considerably below the current market price of the underlying stock. A deep ITM LEAPS is chosen because its price movement closely tracks that of the underlying stock, effectively acting as a capital-efficient substitute for owning 100 shares. This is due to its high delta, often 0.70 or higher, meaning it moves almost dollar-for-dollar with the stock.

The second component involves selling a short-term call option against the long LEAPS. This short call typically has an expiration date much closer than the LEAPS, often weeks or a few months out, and is usually out-of-the-money (OTM), meaning its strike price is above the current stock price. The purpose of selling this short-term call is to collect premium income, which can help offset the cost of the long LEAPS or generate regular cash flow. This combination achieves a similar risk-reward profile to a traditional covered call but with a reduced capital requirement.

Executing the Poor Man’s Covered Call Strategy

First, an investor selects an underlying asset, often a stock or exchange-traded fund, for which they hold a moderately bullish or neutral outlook. The chosen asset should ideally exhibit reasonable liquidity in its options market to ensure efficient entry and exit from positions.

Once the underlying is identified, the next step is to select the long LEAPS call option. This option should be deep in-the-money, with a strike price well below the current stock price. The expiration date for this LEAPS should be far out, typically 1 to 2 years or even longer, to minimize the impact of time decay on its value.

Following the purchase of the LEAPS, a short-term call option is sold. This call option’s strike price is generally out-of-the-money and above the strike of the long LEAPS, allowing for potential stock appreciation before the short call is challenged. Its expiration date is much nearer, commonly 30 to 60 days out, or even weekly, to maximize the benefit from rapid time decay and allow for frequent premium collection.

The entire Poor Man’s Covered Call is typically executed as a single multi-leg order, known as a diagonal spread or debit spread, through a brokerage platform. Investors will specify “buy to open” for the LEAPS call and “sell to open” for the short call, often using a limit order to control the net debit paid for the entire spread. This combined order ensures that both legs are opened simultaneously, establishing the desired covered position efficiently.

Profit and Loss Characteristics

The maximum profit potential for a PMCC is limited and occurs if the underlying stock price reaches or exceeds the strike price of the sold short call option by its expiration. This maximum profit is generally calculated as the difference between the strike price of the short call and the strike price of the long LEAPS, minus the net debit paid for the entire spread (cost of long call minus premium received for short call). For example, if a long call has a strike of $400, a short call has a strike of $450, and the net debit is $15, the maximum profit would be $35 per share.

The maximum loss for a Poor Man’s Covered Call is limited to the initial net debit paid to establish the position. This occurs if the underlying stock price falls significantly, causing both the long LEAPS and the short call to expire worthless. This defined risk is a significant advantage over owning the stock outright, where potential losses can be much larger. The breakeven point for the strategy is typically calculated as the strike price of the long LEAPS plus the net debit paid.

If the stock price is below the short call’s strike price at expiration, the short call expires worthless, and the investor retains the premium collected and the long LEAPS. If the stock price is at or above the short call’s strike price, the short call may be assigned, meaning the investor would sell shares at the strike price. In this case, the long LEAPS provides the necessary “cover” by allowing the investor to exercise it or sell it for its intrinsic value. The strategy benefits from time decay, or theta, which erodes the value of options over time. Since the short-term call option decays at a faster rate than the long-term LEAPS, the strategy profits as the value of the short option declines more rapidly.