Poor Man's Covered Call - What is it? (2024)

FAQs

Poor Man's Covered Call - What is it? ›

In a poor man's covered call, investors replace the shares of stock with a deep in-the-money (ITM) long call that has a longer expiration term than the short call. As a result, investors generally spend significantly less money executing the PMCC while reducing the maximum loss potential as well.

Also known as a synthetic covered call, the options strategy is ideal for smaller accounts. For the year, markets are up, implied volatility is down. The poor man's covered calls strategy (PMCC) can be a profitable technique, especially in a less volatile stock market. PMCC is an efficient use of capital.

The poor man's covered call has too many variables to calculate a specific maximum profit or breakeven point, but there are a few ways to make reasonably accurate estimates: The max profit is approximately equal to the difference between the call strike prices minus the debit paid to enter the position.

A covered call is constructed by holding a long position in a stock and then selling (writing) call options on that same asset, representing the same size as the underlying long position. A covered call will limit the investor's potential upside profit and may not offer much protection if the stock price drops.

Disadvantages of a covered call

One of the reasons you likely own the stock is for its potential to rise over time. By setting up a covered call, you're trading this upside until the option's expiration. If the stock rises, you lose a gain that you could have earned. May “lock up” your stock until option expiration.

In a poor man's covered call, investors replace the shares of stock with a deep in-the-money (ITM) long call that has a longer expiration term than the short call. As a result, investors generally spend significantly less money executing the PMCC while reducing the maximum loss potential as well.

A BABA Poor Man's Covered Call only costs $3,825 in buying power. If the stock prices doesn't rise beyond $110 before expiration, we profit $231 from the short Call premium. If the stock price goes up beyond $110, the maximum profit from the Poor Man's Covered Call is $2,175.

Decline in Stock Value: The most significant risk with a poor man's covered call strategy is if the underlying stock declines in value. Even though you receive a premium from selling the call, that premium might not be enough to offset a significant drop in the stock's underlying price and the long call that you own.

Poor man's covered call at Expiration

The option is "in the money" meaning the stock is above the strike price. if this happens your shares will get sold to the buyer at the strike price and using the above Tesla example if you sold two contracts at the $200 strike well you're going to sell your shares.

The maximum profit on a covered call strategy is limited to the strike price of the short call option, less the purchase price of the underlying stock, plus the premium received.

What happens if nobody buys your covered call? ›

Income potential: When you write a covered call, you get a premium in return. If the buyer never exercises the option because the strike price isn't attractive, you get to keep that premium — and you don't have to sell your stock.

You usually wouldn't want to sell covered calls when the market is very undervalued, for example. Covered calls are a useful tool, and in the hands of a smart investor in the right circ*mstances, can be tremendously profitable.

But if the stock drops more than the premium received from selling the call option, the covered call strategy begins to lose money. In fact, the covered call's maximum possible loss is the price at which the stock was purchased minus the credit(s) from the short calls plus transaction fees.

Losses occur in covered calls if the stock price declines below the breakeven point. There is also an opportunity risk if the stock price rises above the effective selling price of the covered call. Options trading entails significant risk and is not appropriate for all investors.

A covered call is when you own 100 shares of stock and sell a call against them. When you sell a call, you promise to sell your shares at the strike price in exchange for a cash premium. Additionally, for accepting the obligation to sell your shares, you get paid the contract's premium from the call buyer.

According to Taxes and Investing, the money received from selling a covered call is not included in income at the time the call is sold. Income or loss is recognized when the call is closed either by expiring worthless, by being closed with a closing purchase transaction, or by being assigned.

Synthetic Covered Call

This is a strategy that is used to replicate the strategy known as the covered call, which is a popular, and straightforward, strategy that is created with a combination of a long stock position and a short call options position.

For example, if you are already holding a long position on a stock, and you are worried about downside risk, you might enter into a synthetic call option position by buying a put option. By creating the synthetic call, you can still hold onto the underlying stock.

A synthetic call is also known as a married put or protective put. The synthetic call is a bullish strategy used when the investor is concerned about potential near-term uncertainties in the stock.

Why Are Covered Calls Bad? Covered calls are not necessarily bad. It is recommended not to write covered calls for stocks with high growth potential. The reason is that the upside gain will be missed because you'll be required to sell at the strike price.