A Far More Affordable Way to Trade Covered Calls

Yesterday I discussed one of the most popular options strategies among all investors, the covered-call strategy. Buy a stock, sell calls against it. By doing so you can lower the cost basis of your stock or simply use the premium as a source of income.
It’s an easy strategy to implement, but the problem, at least for some, comes down to capital. You must have at least 100 shares of stock to sell a call. For some, acquiring 100 shares just isn’t affordable. Others prefer not to up tie up working capital toward 100 or more shares of stock.
There is an alternative to a covered call strategy. And it’s a good one. In the options world the strategy is referred to as “the poor man’s covered call.”
As an aside, I’m hosting a free training event this week dedicated to this strategy. Click here now to attend – for free.
A poor man’s covered call is similar to a traditional covered call strategy, with one exception in the mechanics. Rather than buying 100 or more shares of stock, an investor simply buys an in-the-money LEAPS call and sells a near-term out-of-the-money call against it.
LEAPS, or long-term equity anticipation securities, are basically options contracts with an expiration date longer than one year. LEAPS are no different than short-term options, but the longer duration offered through a LEAPS contract gives an investor the opportunity for long-term exposure.
Other than reducing the capital required, the reason we purchase LEAPS is to minimize the extrinsic value and theta decay. Basically, a poor man’s covered call is viewed as a diagonal trade with a significantly longer duration.

How I Approach the Poor Man’s Covered Call

First of all, I always start – just like when I use a traditional covered-call strategy – by choosing a low-beta stock. I want a stock with low volatility because the strategy works best when there is minimal vacillation in the underlying stock.
Take, for instance, Wal-Mart Stores (NYSE: WMT).

The stock exemplifies the typical low-beta, blue chip stock that I look for when using a poor man’s covered call strategy.
The next step is to choose an appropriate LEAPS contract to replace buying 100 shares of WMT stock.
If we were to buy WMT stock at $71.22 per share, our capital requirement would be a minimum of $7,122 plus commissions ($71.22 times 100 shares).
If we look at WMT’s option chain, we will quickly notice that the expiration cycle with the longest duration is the January 2018 cycle, which has roughly 512 days left until expiration.
With the stock trading at $71.22, I prefer to buy a contract that is in the money at least 10%, if not more. Let’s use the $60 strike for our example.
We can buy one options contract, which is equivalent to 100 shares of WMT stock, for roughly $13.10. Remember, always use a limit order – never buy at the ask price, which in this case is $13.35.
If we buy the $60 strike for $13.10, we are out $1,310, rather than the $7,122 we would spend for 100 shares of WMT. That’s a savings on capital required of 81.6%. Now we have the ability to use the $5,812 in capital saved to work in other ways.
The next step is to sell an out-of-the-money call against our Jan 2018 60 call LEAPS contract.
It seems as though the only call strike worth selling in WMT is the October $72.5 strike with 57 days left until expiration. If we chose a stock with a slightly higher price we could go out two, three, four or more strikes away from the current price of the stock. But, I want to use a very conservative example so we understand the basic risk/reward.
So, let’s say we decide to sell the $72.5 strike for $1.17, or $117, against our $60 LEAPS contract.
Our total outlay or risk now stands at $1,193 (Cost of LEAPS contract minus premium of $72.5 call).

Free Event on Poor Man’s Covered-Call Strategy

We can continue to sell calls against our LEAPS contract every month or so to lower the total capital outlay. But remember, options have a limited life, so when we get closer to the LEAPS contract’s expiration we will simply sell the contract and use the proceeds to continue our poor man’s covered call strategy.
We actually introduced Wal-Mart to our Poor Man’s Covered Call Portfolio at the onset of 2016. During that time, shares of WMT have pushed 26% higher. We’ve made over 70% during that same time frame using a poor man’s covered-call strategy.
If this sounds like a strategy you’re interested in, you can attend my free webinar training event this week.