The poor man's covered call. Capital efficient income.

Q: What is a poor mans covered call?

A poor mans covered call (PMCC) is a diagonal spread that combines a long deep in the money LEAPS call (acting as the underlying stock substitute) with a short shorter dated out of the money call sold against it. The structure produces income similar to a standard covered call but with much less capital tied up because the LEAPS costs a fraction of buying 100 shares.

Q: How much capital does a PMCC save?

Substantial. A standard covered call on AAPL at $200 requires $20,000 to buy 100 shares. The PMCC equivalent buys a deep in the money AAPL LEAPS for $5,000 to $8,000 depending on the strike chosen. The trader controls similar directional exposure for 25 to 40 percent of the capital. The freed capital can be used for additional positions or kept in cash earning interest.

Q: What is the risk of a poor mans covered call?

Three main risks. One, the LEAPS decays with time (small daily decay but it adds up). Two, the short call can be assigned if the underlying rallies hard above the short strike. Three, if the LEAPS goes out of the money on a major decline, the position can lose substantial premium. The total maximum loss is the cost of the LEAPS minus any net credits received from the short calls.

Q: When does PMCC beat a standard covered call?

PMCC beats standard covered call when capital is constrained. The trader who would use $20,000 on 100 shares of AAPL can instead use $7,000 on a LEAPS and have $13,000 for other positions. Standard covered calls beat PMCC when the trader wants dividends from the underlying (LEAPS holders do not receive dividends) and when the underlying has expensive LEAPS that erode the capital savings.

By Andrew Villagomez · chartmaster3000

The poor man's covered call (PMCC) is the capital efficient cousin of the standard covered call. Instead of buying 100 shares of stock, the trader buys a deep in the money LEAPS call. The LEAPS acts as the underlying stock substitute. Short term calls are sold against it to collect premium. The structure produces income similar to a standard covered call but with much less capital tied up.

The PMCC fits traders with limited capital who want covered call income on high priced stocks they could not afford 100 shares of. The trade off is management complexity and the time decay on the long LEAPS.

How a PMCC actually works

AAPL at $200. A standard covered call requires owning 100 shares ($20,000) and selling a short term call.

The PMCC alternative.

Buy an AAPL $160 call expiring 18 months out. Premium might be $50 per share, or $5,000.

Sell an AAPL $210 call expiring 30 days out. Premium might be $3 per share, or $300.

The trader owns the long LEAPS as the directional exposure. The short call generates income. If AAPL stays below $210 at the short call expiration, the short call expires worthless and the trader keeps the $300. Sell another short call for the next 30 days.

If AAPL rises above $210, the short call goes in the money and may be assigned. The trader can close the short call early, roll it, or let it be assigned (in which case the LEAPS gains value to offset the loss on the short call assignment).

The capital comparison

Standard covered call on AAPL at $200.

Capital required: $20,000 (100 shares).

Monthly premium from 0.20 delta call: roughly $200 to $400.

Monthly yield on capital: 1 to 2 percent.

PMCC on AAPL at $200.

Capital required: $5,000 (deep in the money LEAPS).

Monthly premium from short call: roughly $200 to $400 (similar to standard).

Monthly yield on capital: 4 to 8 percent.

The capital efficiency improvement is the primary attraction of PMCC. The same income on a quarter of the capital.

The LEAPS selection

The long LEAPS should be deep in the money to behave like the underlying. Target delta 0.80 to 0.90.

Time to expiration. 12 to 24 months out. Longer is more capital but less time decay per day. Shorter is less capital but more decay per day.

Most PMCC traders settle on 18 month LEAPS at 0.80 delta as the sweet spot. The position has minimal daily theta and behaves nearly identically to owning the shares while costing about a quarter of the capital.

The short call selection

Same delta range as standard covered calls. 0.20 to 0.30 delta short call.

30 to 45 days to expiration. Same theta efficiency window as standard covered calls.

The short call strike must be above the long LEAPS strike. The width between the two strikes determines the maximum profit on the position if the short call is assigned.

AAPL $160 LEAPS plus AAPL $210 short call. If AAPL closes above $210 at short call expiration, the short call is assigned. The trader closes the LEAPS to deliver the shares (or closes both legs simultaneously). The profit is the difference between the strikes ($50) plus the premiums received minus the LEAPS cost.

PMCC trades capital for complexity. The capital saved is real. The management workload is higher than a standard covered call. The fit depends on which constraint matters more to the trader.

The management rules

Close at 50 percent of short call premium.

Same as standard covered calls. The short call decays fastest in the final two weeks. Closing at 50 percent of max profit captures the optimal risk reward.

Roll the short call before assignment.

If the short call approaches the money near expiration, roll it to a higher strike or further expiration to avoid assignment. The roll collects additional premium.

Monitor the LEAPS.

If the LEAPS gets deep in the money (delta approaching 1.0), the position behaves like owning the stock. If the LEAPS goes out of the money on a decline, the position can lose value rapidly. Manage the long LEAPS as well as the short call.

Roll the LEAPS at 90 to 120 days.

Before the LEAPS enters its accelerating theta phase, roll to a new LEAPS one to two years out. The roll preserves the long term exposure.

What kills PMCC traders

Picking LEAPS too short dated. A 6 month LEAPS has too much theta drag to function as a stock substitute. The position loses value to time even when the underlying does not move.

Picking LEAPS too low delta. A 0.50 delta LEAPS is more like a long call directional bet than a stock substitute. The PMCC math does not work as well.

Selling short calls too close to the money. The short call gets assigned frequently. The position turns over too often and produces transaction cost drag.

Ignoring the share decline risk on the LEAPS. If AAPL drops 30 percent, the LEAPS can lose 50 percent or more of value depending on delta. The short call premium does not compensate for the LEAPS loss.

Holding the LEAPS too long into theta acceleration. The final 90 days of LEAPS life produce most of the time decay. Roll out before this window.

The tax treatment

PMCC has more complex tax treatment than standard covered calls. The short call premium is short term capital gain. The LEAPS gains or losses are taxed based on the holding period at sale (over one year is long term, under is short term).

Closing the LEAPS for a long term gain while continuing to sell short calls produces mixed tax treatment that complicates Schedule D reporting.

Consult a tax professional for active PMCC programs. The bookkeeping is more involved than standard covered calls.

When PMCC beats standard covered call

Capital is the limiting factor. The trader who would need to choose between 100 shares of AAPL or 100 shares of MSFT can run PMCC on both with the same total capital.

The stock pays no dividend. LEAPS holders do not receive dividends. If the dividend is meaningful, the standard covered call is more attractive. If the dividend is minimal or zero, the LEAPS structure loses less.

The stock is in a slow grind. PMCC works best when the underlying chops sideways or grinds slowly upward. Strong rallies cause repeated assignments. Sharp drops produce LEAPS losses.

When standard beats PMCC

The trader has sufficient capital. The complexity of PMCC is not worth it when the capital is available for shares.

The stock pays a meaningful dividend. The dividend income on shares is missed by LEAPS holders.

The trader wants to hold the underlying long term. Owning shares is simpler than rolling LEAPS every 12 to 18 months.

The trader is new to options. Standard covered calls have one variable (the short call). PMCC has multiple. Start simple.

Where the audit fits

The audit reads the actual PMCC entries and shows whether the LEAPS strike, expiration, and short call selection match the strategy intent. For most retail PMCC traders the pattern is picking LEAPS too short or too low delta. The plan locks the structural rules. Five to seven pages.

The next move

PMCC rules on paper in 48 hours.

If you run PMCC and the math is not working, the audit reads the record and locks the LEAPS and short call rules.

Start your intake Read what's included

Questions, answered.

What is a poor mans covered call?

Diagonal spread. Long deep ITM LEAPS plus short ATM call. Income similar to covered call with less capital.

How much capital does a PMCC save?

25 to 40 percent of the cost of 100 shares. AAPL covered call $20K. PMCC $5K to $8K.

What is the risk of a poor mans covered call?

LEAPS time decay. Short call assignment risk. LEAPS losing value on decline. Total max loss is LEAPS cost minus credits.

When does PMCC beat a standard covered call?

When capital is constrained and the underlying has minimal dividends. Standard wins for dividend stocks and traders with sufficient capital.

— Andrew Villagomez (chartmaster3000)

ZenEdge is a brand under Gant Villagomez Capital. Andrew Villagomez is not a registered investment advisor, broker dealer, financial planner, or fiduciary. Nothing on this page constitutes investment advice or a recommendation to buy, sell, or hold any security. You are solely responsible for your own trading decisions, position sizing, risk management, and outcomes. Trading involves risk of loss, including total loss of capital.