Poor man's covered call

The poor man's covered call is a capital-efficient alternative to the traditional covered call. Instead of buying 100 shares of stock to sell calls against, you buy a deep in-the-money LEAPS call as a stock substitute, then sell short-term calls against it. The result is a covered-call-like income strategy that requires a fraction of the capital.

Bias: Bullish Risk profile: Defined (limited to the net debit paid) Ideal conditions: Bullish on a stock long-term, want covered-call income without the capital to buy 100 shares

How it is constructed

The poor man's covered call is technically a long call diagonal spread:

• Buy 1 deep in-the-money LEAPS call (long-dated, high delta, acts as your stock substitute)
• Sell 1 shorter-term out-of-the-money call (generates income, just like a covered call)

The LEAPS call replaces the 100 shares of stock. Because a deep ITM LEAPS call behaves much like owning the stock (high delta) but costs far less, you get similar income potential with much less capital tied up.

Setup example

AAPL is trading at $190. A traditional covered call would require buying 100 shares for $19,000. Instead:

• Buy the $150 LEAPS call expiring in 12 months for $48.00 (cost: $4,800)
• Sell the $200 call expiring in 30 days for $2.50 (collect: $250)

Net debit: $4,800 minus $250 = $4,550

You now control AAPL exposure similar to owning shares, but for $4,550 instead of $19,000, roughly a quarter of the capital.

How income is generated

Just like a covered call, you sell a short-term call each month against your long LEAPS. Each month the short call expires worthless (if the stock stays below the short strike), you keep the premium, and you sell another one.

Over time, the premium collected from the monthly short calls reduces your net cost in the LEAPS. If you collect $250 per month for several months, you steadily lower your effective cost basis in the position.

Max profit and max loss

Max loss: the net debit paid ($4,550 in this example), which occurs if AAPL falls dramatically and the LEAPS loses most of its value. This is your defined risk.

Max profit: achieved when the stock rises to the short call strike at the short call's expiration. The LEAPS gains value while the short call is at its maximum profitable point before going in the money.

The exact max profit depends on the relationship between the two strikes and the value of the LEAPS at the short call expiration, but it is realized when the stock sits right at the short strike.

Poor man's covered call vs traditional covered call

• Capital required: the poor man's version requires far less capital (the LEAPS cost vs 100 shares). This is the primary advantage.
• Dividends: a traditional covered call collects dividends on the shares you own. The poor man's version does not, since you own a call, not shares. This is a disadvantage for dividend stocks.
• Risk: the traditional covered call's downside is the stock going to zero (large but you own a real asset). The poor man's version's downside is limited to the net debit, which is smaller in absolute dollars.
• Assignment on the short call: in both versions, if the short call goes in the money, you may be assigned. In a traditional covered call you simply deliver your shares. In the poor man's version, you may need to exercise your LEAPS or close the position to cover, which requires more active management.

When to use it

Best conditions:

• You are bullish on a stock long-term but do not have the capital to buy 100 shares
• IV rank is low enough that the LEAPS is not too expensive to buy
• You want covered-call-style monthly income with less capital at risk
• The stock does not pay a significant dividend (or you do not mind forgoing it)

Avoid when:

• You want to collect dividends (own the shares instead)
• IV is very high, making the LEAPS expensive to buy
• You are not able to actively manage the short call if it goes in the money

Managing the position

Each month, if the short call expires worthless, sell a new short call for the next month at a strike reflecting your outlook.

If the stock approaches your short call strike, you can roll the short call up and out to avoid assignment and give the position more room.

If the stock rises significantly, you may need to manage the risk that your short call goes deep in the money faster than your LEAPS gains value. This is the main management challenge of the strategy.

As the LEAPS approaches expiration (with several months left), consider rolling it out to a later expiration to maintain your stock substitute, or closing the entire position to realize gains.

Related terms: Diagonal spread, LEAPS, covered call, delta, theta, defined risk

Try it on Stryke: Screen for deep ITM LEAPS and suitable short call strikes to build a poor man's covered call in the Options Screener.