Poor Man's Covered Call vs. Covered Call: Which Fits Your Account?
Feeling the capital crunch for covered calls?
Many traders love the idea of selling covered calls for consistent income, but the thought of tying up thousands of dollars for 100 shares of stock can be a non-starter. What if you could get similar premium income with a fraction of the capital?
Enter the Poor Man's Covered Call, or PMCC. This strategy offers a capital-efficient alternative to the traditional covered call, but it comes with its own set of risks and considerations. Let's break down both.
The classic: Covered Call
A standard covered call is straightforward: you own 100 shares of a stock and sell one out of the money (OTM) call option against those shares. You collect the premium, and if the stock stays below your strike price, you keep the shares and the premium.
It's a popular strategy for those with a neutral to moderately bullish outlook on a stock they already own or are happy to acquire. The main downsides are the significant capital required to buy 100 shares and the capped upside if the stock rallies hard and gets called away.
The capital-efficient alternative: Poor Man's Covered Call (PMCC)
The PMCC replaces the 100 shares of stock with a long-dated, deep in the money (ITM) call option, typically a LEAPS contract. A LEAPS is a Long-term Equity Anticipation Security, essentially a call option with an expiration date usually more than a year out.
By buying a deep ITM LEAPS, you gain exposure to 100 shares of stock with significantly less capital. You then sell a shorter-term, out of the money call option against that LEAPS, just as you would with actual shares. This structure is technically a debit spread, so understanding options spreads is key.
Comparing capital and returns for AAPL
Let's look at a hypothetical scenario with Apple (AAPL) trading at $170 per share. We'll use a short call with 40 days to expiration and a $175 strike price, collecting $2.50 per share ($250 per contract).
| Strategy | Underlying Asset | Cost of Underlying | Premium Collected (Short Call) | Net Capital Outlay | Max Profit (Short Call) | Dividends | Complexity |
|---|---|---|---|---|---|---|---|
| Covered Call | 100 Shares AAPL | $17,000 | $250 | $17,000 | $250 | Yes | Low |
| PMCC | 1x AAPL Jan 2025 $130C LEAPS | $4,500 | $250 | $4,500 | $250 | No | Moderate |
As you can see, the PMCC significantly reduces the capital required to generate the same premium income from the short call. In this example, it's over 70% less capital upfront.
The risks and catches
While attractive, the PMCC isn't a free lunch. Here are the main considerations:
- No dividends. Since you don't own the underlying shares, you won't receive any dividends.
- LEAPS theta decay. While slower than short-term options, your long LEAPS still loses value over time. You need to manage this decay by rolling or closing the position before it becomes too significant.
- Bid-ask spread. LEAPS often have wider bid-ask spreads than highly liquid short-term options, which can eat into your entry and exit prices.
- Early assignment. If your short call is assigned early, you'll have to either close your LEAPS or buy shares to cover. This can be trickier than with a traditional covered call.
- Delta risk. If the underlying stock drops significantly, your deep ITM LEAPS will lose value, potentially faster than 100 shares of stock due to gamma.
- Complexity. It is a spread strategy, which means understanding how two options interact. This adds a layer of complexity compared to simply owning shares and selling calls.
Which strategy fits your account?
The choice between a covered call and a PMCC largely depends on your account size, risk tolerance, and investment goals.
Choose a Covered Call if:
- You have sufficient capital to purchase 100 shares of your desired stock.
- You want to receive dividends.
- You prefer a simpler, more direct strategy.
- You're trading in an IRA or other account where capital efficiency isn't the primary concern.
- You have a neutral to moderately bullish outlook.
Choose a Poor Man's Covered Call if:
- You have a smaller account and need capital efficiency to get started.
- You have a stronger bullish conviction on the underlying stock.
- You are comfortable with options spreads and managing multiple legs.
- Dividends are not a priority for your investment strategy.
- You understand and accept the additional risks of a spread strategy.
Final thoughts
Both strategies aim to generate income from selling options, but they take different paths. The standard covered call offers simplicity and dividends, while the Poor Man's Covered Call provides capital efficiency. Understand the mechanics and risks of each before deciding which one best aligns with your trading style and account.