In-The-Money Covered Call Explained

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Poor Man’s Covered Call — Introduction and Real Trade Analysis

The Poor Man’s Covered Call (PMCC) is an options strategy that enables one to sell covered calls at a fraction of the capital required than if he were to hold the underlying asset. The following is quoted from what TastyTrade defines a PMCC is:

A “Poor Man’s Covered Call” is a Long Call Diagonal Debit Spread that is used to replicate a Covered Call position. The strategy gets its name from the reduced risk and capital requirement relative to a standard covered call.

I am a fan of the Wheel strategy (which involves selling cash-secured puts, selling covered calls in a loop with stocks involved), and the covered call writing is part of the wheel strategy. Personally, this strategy is a low risk and high reward strategy, if the right stocks and right way are applied to manage the trade. However, this strategy generally only works on stocks that are neutral or slightly bullish. With the current market conditions, I am slightly hesitant to enter any positions as even good and strong stocks are falling due to market fear. The PMCC will limit the absolute loss of this strategy since your required capital is much lower, but do note that in terms of percentage, you will probably lose more, since there is time decay involved in options but not in stocks, and you can hold stocks for as long as you want till it recovers. This is why managing the position is so important compared to just covered call writing.

What is a PMCC actually?

The typical PMCC consist of two call options.

    A long deep in-the-money (ITM) LEAPS call option (

0.80 Delta). This call option acts like a stock, it gives you the coverage of selling a call option, and being deep ITM, the 0.8 Delta will ensure the option moves as close to the stock as possible. There is some flexibility here, some people like going for 0.7, while some like to play it safe and go for 0.9 Delta. Any way works, depending on your risk appetite. LEAPS, which stands for Long Term Equity Anticipation Security, are options that expire much much later. You can find LEAPS that expire as far as about 2years later. LEAPS are used because they are the least affected by time decay compared to nearer-term options. I generally go for the furthermost possible LEAPS, to buy myself more time, do note that you will be paying more for time decay so longer LEAPS will be more expensive.
A short out-of-the-money (OTM) call option (

0.30 Delta). Selling an OTM call option allows one to collect some income while holding on to a particular stock, and also sell it at a higher price if the option gets exercised. I generally go for 0.3 Delta as this is close to the 1 standard deviation of where the stock would move to (1SD =68%). Some people sell these calls weekly, some sell them monthly, I personally prefer to do it weekly because I’m slightly more active in monitoring the markets and any unexpected moves I would be able to manage it accordingly.

My current positions:

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I have opened 4 PMCC positions so far, 2 have been closed while 2 are currently still open. I will cover each position and show the pros and cons of the PMCC.

1st Trade: Bank of America (BAC) — CLOSED

I purchased a BAC LEAP Call option expiring 15Jan2021 with a strike price of $25 for $600 on 2Apr2020. The stock price then was $28.50. This means that from now till 2021, I can choose to buy 100 BAC shares for $25 each. This might be confusing to newer options traders or nontraders, the standard question would be “Hey K, why don’t you just exercise the option now and purchase the stocks at $25 and sell it at $28.50? You will make $350 in total instantly!” That is absolutely true! But don’t forget how much you paid to buy this ‘right’ to purchase the stock at $25. $600! That would mean you would have an instant loss of $250! If making money was that easy, everyone would be rich! Okay going back to the topic, you can ignore the closing position for now, as we look to the short side to see what trades were taken.

I sold a 2-week expiry remaining call option and collected a premium of $0.32. The current stock price is $28.50, and my strike is $29.50. As long as the stock price does not hit $29.50 at expiry, I will be able to keep the full premium. Note that even if price rally above $29.50 but falls back below this level by expiry, I will still be able to collect the full premium as the option will expire worthless. The goal is to let the short option expire because you are collecting a small amount of premiums, and would prefer not to close it to incur more commission fees. However, do note that some brokers do not charge if the value of your option is below a certain amount. For ToS that I’m using, any closing any position with a value of $0.05 or less, there is no commission charge. This entices me to close it earlier so I will not be subjected to more market volatility. As you can see above, I actually closed this position at a loss on expiration because the stock went past my strike price to $30. This means that I will be exercised at the end of the day. Normally I wouldn’t need to be scared because I do have my long position that I can exercise and give the shares to the buyer, but there will be an additional exercise fee of $15 if that happens. Always remember, we need to know all the cost of our trades and try to minimize it. Since my long position has a higher delta, the loss in my short position due to the up-move in the stock will be offset by the gains of my long position. I would still be profitable in the overall position.

This is the final summary of my trade. Although incurred a loss of $12 from the short call, my long call made $76. That means I made $64, on a $600 initial investment. After taking into account commissions, my net ROI is 11.77%, for a period of 16 days. Pretty decent if you ask me.

2nd Trade: Sketchers USA(SKX) —OPEN

Sketchers has been a solid stock with good fundamentals, and I foresee it to have a steady growth in the business as well as the stock price, which is why I chose it as a candidate for PMCC. I opened a 2021 LEAP option with a strike price of $30 and a premium paid of $1050. The stock price at open was $34.

Above table shows the short positions I had. I initially sold a monthly call option for $1.46, a 14% ROI trade! This was achieved with 9 days after Sketchers announced earnings and the stock price plunged. With only $0.05 value left in the option, i decided to buy it back to close it and realized my $141 profit. I waited to enter another position since there is also a good possibility that price might rebound after the sharp drop. After somewhat stabilising, I entered another short position on 30th Apr, this time choosing a weekly option to have better management of the trade. This trade expired worthless on 3rd May. by this time, SKX stock price as taken a beating and has fallen below $30, the strike price of my long option. This means that I’m no longer protected if should my short call gets exercise. I’m hesitant to take a position and waited on the sidelines to see where the price was heading. It never recovered. SKX broke past the 200SMA and should look to continue to drop in the short term. I decided to open a weekly position on 30th May to continue earning some small premiums to minimize my loss, if I’m right on the short term trend, I should be able to make some decent premium and hopefully breakeven.

The final summary will not be reflective of the trade as it treats my long position as a 100% loss until I close the trade so I will use this PMCC template I got online for a summary. As you can see, my current ROI from my short positions is about 16%, provided my opened short position expires worthless. However since I’m not covered, I will look to close my position on expiry day to prevent assignment. My current loss on my long position is $505, about 50%, so I’m about 34% down in this position. My strategy would be to continue selling tightly managed calls till about 2 weeks before the next earnings, and hope the stock price recovers.

3rd Trade: Bank of America (BAC) — CLOSED

Less explanation is needed now as the flow of the trade is the same. $830 of premium paid for a LEAP option.

My short positions. I closed 2 positions as they were below $0.05 and I didn’t have to pay commissions so there was no reason not to close it.

Final summary, lost $22 on my shorts, made $82 on my longs, net profit of $60, net ROI of 8.74% over a period of 11 days. BAC has also taken a beating with the trade war tensions and is sitting at $26.60 currently. It’s a great stock for the PMCC strategy and I’m looking to open one as soon as there is some stability in the markets.

4th Trade: NIO INC (NIO) — OPEN

I bought 5 contracts of NIO on 22Apr for the PMCC strategy. Personally, I didn’t think this stock was a good candidate because it didn’t have strong fundamentals, and is probably super volatile. But I noted that the premium was really juicy and based on the charts, the odds of it falling below $4 seem unlikely. This is a case of ‘there are no such things as how low a stock can go’. It can ALWAYS go lower, and likewise, always go higher. This goes to show how important trade management is. As we all know, NIO is currently sitting at $3.05 lul. Being a Chinese EV company, this trade war will not be friendly to NIO at all. I’m even considering selling my LEAP at a loss now, but it’s uncertain how the trade war will play out in the coming months, so I will leave it for now.

My most actively managed position among the 4. Being a volatile stock, I had to close positions at expiration dates if the price was very near to the strike price to avoid assignment. Similarly, my long position is no longer covering my shorts so any selling I do will need to be managed accordingly.

My current ROI for my shorts is 23%, but my LEAP is down $627.50, about 60%. Similarly, I’m down 37% on NIO. Let’s see how this plays out in the coming weeks!

Equity Options Practice questions

Термины в модуле (83)

If both expire unexercised, the profit or loss is:

Sell 1 ABC July 70 call 4
buys 1 ABC July 60 call 7

Maximum loss potential is the net debit in the premiums

Long 200 shares ABC common stock
Long 1 ABC Oct 30 calls
Long 2 ABC Oct 30 puts

On July 1, the customer enters the following orders:

Sell 200 ABC at the market
Buy 1 ABC Oct 30 call

After the above trades the remaining position would be a:

Long 1 XYZ May 40 call and short 1 XYZ May 50 call.
Long 1 ABC July 30 call and long 1 ABC October 30 put.
Short 1 EFG January 50 call and short 1 EFG January 60 put.
Short 1 DIS April 40 call and short 1 DIS July 50 call.

Long WLC calls
Long WLC puts
Short WLC puts

Long Calls & Short Puts are on the same side of the market

Strike $40
Market 35
Intrinsic 5 pts

I. The maximum gain is unlimited.
II. The maximum loss is limited.
III. The maximum gain is limited to the premium received.
IV. The maximum loss is limited to the premium received.

Long the underlying stock
Escrow receipt on the underlying stock
Depository receipt on the underlying stock

At what market price would the customer breakeven?

debit call spread

take net debit added to the strike price of the long call

I sale proceeds for tax purposes if exercised of $74/share
II. sale proceeds for tax purposes if exercised of $70/share
III. ost basis of the stock for tax purposes if unexercised of $61/share
IV. cost basis of the stock for tax purposes if unexercised of $65/share

In the event that there is an exercise, the investor has sale proceeds on the exercise of $74 in this scenario, because the stock will be sold at $70 per share and premiums totaling $4 per share were collected.

No exercise = no change in cost basis

Premiums Stock Trans.
B – 500 B – 3,500
– 4000

Premiums Stock Trans.
B – 700
S + 200
– 500

When determining the breakeven on a debit put spread, you always take the net debit subtracted from the strike price of the long put (60 – 5 = $55 per share breakeven)

I. Debit Spread
II. Credit Spread
III. Bullish Spread
IV. Bearish Spread

Premiums Stock Trans
B – 600
S + 200

Premiums Stock Trans.
B – 600 B – 7,000
– 7,600
– 7,600.200= $38 breakeven

The break even price of the stock before expiration is:

When determining breakeven on a call spread done at a net debit, you take the net debit (-9) and add it to the strike price of the LONG position (Long 1 Nov 60 Call).

The break even price would therefore be: 60 + 9 = 69.

Buyers of Puts want the Market Value to go down because buyers of puts, have the right to sell stock. If the market value of the underlying stock goes down, then we can buy the stock for a lower price than exercise the option and sell the stock for the higher price.

I. A depository receipt
II. The underlying security
III. An escrow receipt

I. A customer puts on a short straddle.
II. A customer sells a company’s common stock short and buys one long call option.
III. A customer buys a company’s common stock and sells a call.
IV. A customer sells a naked call.

The customer will break even at what market price?

I. A put contract with a strike price that is higher than the market price of the underlying common stock.
II. A put contract with a strike price that is lower than the market price of the underlying common stock.
III. A call contract with a strike price that is higher than the market price of the underlying common stock.
IV. A call contract with a strike price that is lower than the market price of the underlying common stock.

I. Sell one XYZ call
II. Sell one XYZ put
III.Buy one XYZ call
IV. Buy one XYZ put

I. It may be exercised immediately upon purchase.
II. It is a wasting asset.
III. If it is out-of-the-money, it has no intrinsic value.
IV. It belongs to one of two classes of options (Calls or Puts).

I. Shorting a call
II. Buying a call
III. Writing a put
IV. Buying a put

Shorting or writing = initial sale, therefore

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