An Explanation of the Poor Man Covered Call
If you are new to trading options, then chances are you are quite surprised at just how many trading strategies are out there. However, this is actually good news for you because it means that you have a greater chance of being successful as long as you learn as many trading strategies as possible. One example of a solid options trading strategy would be the Poor Man’s Covered Call. Does this sound interesting? Let’s take a closer look:
What is a Poor Man’s Covered Call?
According to tastytrade, the Poor Man’s Covered Call (abbreviated PMCC) is an options trading strategy where an individual “can sell all of their covered calls at a small fraction of the capital they would need if they had actually held the underlying asset…it is defined as a Long Call Diagonal Debit Spread which can be used to simply be a copy of an ordinary Covered Call position.” This strategy will take its name from the reduced amount of risk and the smaller amount of required capital.” Of course, this is often a very bullish type of options trading strategy. The problem with a normal options trading strategy is that you run the risk of incurring a complete and total loss if the option goes the long way. The good news with the Poor Man’s strategy is that it can help you avoid that, albeit with a smaller gain as well.
When should a Poor Man’s Covered Call be used?
The main instance where you should consider using this options trading strategy would be when you are in the middle of a bullish market. Additionally, this strategy should be used when you want a “longer-dated position” that will account for things such as major world crises such as the COVID-19 pandemic. Additionally, a Poor Man’s Covered Call should be utilized when the investor wants to buy an in-the-money position with a longer-term expiration cycle. This generally works in tandem with an out-of-the-money call for a near-term expiration cycle. In a sense, the investor is placing an “extra” investment as insurance just in case the other one goes sour on him.
How does a Poor Man’s Covered Call work?
First of all, it’s important to realize that the Poor Man’s Covered Call is a particular kind of spread. For example, one of the main reasons why you would do a Poor Man’s Covered Call in the first place is when you don’t have a tremendous amount of money to invest in traditional stocks. Thus, instead of purchasing stock, you would purchase a deep-in-the-money call at a later expiration than a normal stock. Furthermore, you would ideally want an investment option where the call option has a delta of at least 0.95, meaning that for every dollar your call option moves, your investment is gaining 0.95 in value.
Of course, like everything else in life, there is a downside to this strategy. Simply put, your profit is limited. If you execute a Poor Man’s Covered Call and the underlying stock has a huge movement, your profit will be limited. However, this is definitely a good way to prevent yourself from incurring a tremendous loss as well.