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Today I want to teach you about a unique strategy you can use on one of your favorite stocks.
The strategy is known as a poor man’s covered call.
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.
As an example of the poor man’s covered call, I’ll use one of my most recent positions. . . Boeing (NYSE: BA). We closed out a 128.5% return on this stock recently using our poor man’s covered call approach.
The first step in the poor man’s covered call strategy is to choose an appropriate LEAPS contract to replace buying 100 shares of BA.
If we were to buy BA shares at $329.98 per share, our capital requirement would be a minimum of $32,998 plus commissions ($329.98 times 100 shares). We want to reduce the cost of the shares by roughly 80% . . . this is how it’s done.
If we look at BA’s option chain, we will quickly notice that the expiration cycle with the longest duration is the January 2020 cycle, which has roughly 672 days left until expiration.
With the stock trading at $329.98, I prefer to buy a contract that has a delta around 0.75 to 0.80.
The $250 strike fits the bill.
We can buy one options contract, which is equivalent to 100 shares of BA, for roughly $101.20, if not cheaper. Remember, always use a limit order – never buy at the ask price, which in this case is $102.70.
If we buy the $250 strike for $101.20 we are out $10,120, rather than the $32,998 we would spend for 100 shares of BA. That’s a savings on capital required of 69.3%. Now we have the ability to use the capital saved ($22,878) to work in a variety of other ways.
The next step is to sell an out-of-the-money call against our LEAPS contract.
I like to go out roughly 30 to 60 days when selling premium against my LEAPS contract. Let’s sell the May 335 strike with 63 days left until expiration for $15.40. We can use this as income or to lower the cost basis of our position.
Our total outlay or risk now stands at $8,580 ($10,120 for the LEAPS contract minus $1,540 for 240 call). On a percentage basis, selling the May 335 call premium for $15.40 reaps a return on capital of 15.2% over 63 days
An alternative technique, if you wish to participate on a continued upside move in BA, is to buy two leaps in the stock and only sell one call against it. This strategy will increase your deltas and allow half of your position to participate in a move past $335, but I’ll save this approach for a different day.
No matter the approach, we can continue to sell calls against our LEAPS contract every month or so to create a steady and diversified stream of income. A reliable income stream that most of us were never aware of. Do your due diligence, take the time to learn the poor man’s covered call strategy and you will be rewarded with one of the best opportunities for income the market has to offer.