The covered call is a popular Option strategyin order to generate additional income from an existing share position. In order to be able to trade the strategy, at least 100 shares of the underlying stock must be purchased, since a stock option refers to 100 shares. At a share price of e.g. 200 USD this would mean an investment of 20 000 USD. For those who do not want to or cannot spend this amount, the Poor Man's Covered Call is an alternative that requires less capital outlay. In this article you will learn what a Poor Man's Covered Call is, when it makes sense to use it and what to look out for in this strategy.
Definition Poor Man's Covered Call
The Poor Man's Covered Call is an option strategy in which a deep in-the-money call option with a long maturity is first purchased. Subsequently, a Call option sold with a shorter maturity (usually above the current share price). The strategy thus attempts to replicate a "conventional" covered call by trading an ITM long call instead of a share.
Technically, the Poor Man's Covered Call is a long diagonal debit spread. Compared to a Covered Call where 100 shares are bought, the capital requirement or margin requirement is significantly reduced. The Poor Man's Covered Call is therefore also suitable for smaller accounts.
What to look for when trading a Poor Man's Covered Call
The objective of a Poor Man's Covered Call is to replicate a Covered Call. The Long Call is intended to "simulate" a long position in the stock. For this purpose, it is necessary to choose a deep in-the-money option. Option traders are usually guided by the option index for this purpose Delta. A delta of 1 or 100 (percent) would mean that the risk profile of the option is identical to the stock. For a Poor Man's Covered Call, options with a delta of 0.9 or higher are often chosen. In principle, however, a long call with a lower delta can also be chosen.
Maximum loss
The risk of the Poor Man's Covered Call is a sharp fall in the share price. The maximum loss occurs if the long position is held until the expiration date and the option expires worthless (Out Of The Money).
Max. Loss = Option premium Long Call - Option Premium Short Call
Maximum profit
The maximum profit cannot be determined exactly because the options have different expiration dates.
Break Even Point
The exact break-even point can also not be determined exactly. As an approximation, the break-even point can be determined by adding the option price paid to the strike price of the long call.