Poor Man's Covered Call: 3 Advanced Tactics for HUGE Profit!

This article expands upon the fundamentals of the poor man's covered call strategy, providing three advanced tactics to potentially increase profits. These tactics are based on personal experience and professional training. It's recommended to review the foundational concepts before proceeding.

Understanding the Poor Man's Covered Call

A poor man's covered call involves two components:

• Long Call Option: Buying a deep in the money call option.

• Short Call Option (Covered Call): Selling a call option, typically out of the money.

Extrinsic Value Manipulation: Tactic 1

This tactic focuses on minimizing the extrinsic value paid for the long call while maximizing the extrinsic value received from the short call.

• The long call option's value comprises extrinsic and intrinsic value.

• The short call option (covered call) consists entirely of extrinsic value, since it's out-of-the-money.

The goal is for the premium received from selling the covered call to offset the cost of the extrinsic value within the long call. Ideally, if you pay $1 in extrinsic value for the long call, you want to collect approximately $1 by selling the covered call. Thus, you effectively only pay for the intrinsic value of the long call.

Selecting Option Strikes

Consider the following when selecting strikes, focusing on minimizing extrinsic value paid and maximizing extrinsic value received:

1. Long Call Option:

   • Days to Expiration: Choose the furthest date available (LEAPS). This provides more time for the trade to become profitable and reduces theta decay (the erosion of extrinsic value). While some recommend 180 days, longer durations can simplify the strategy and are more appropriate for fundamentally sound stocks.

   • Extrinsic Value: Aim to pay as little extrinsic value as possible. Review the option chain for the lowest extrinsic value.

   • Cost: Do not pay more than 50% of what it would cost to buy 100 shares of the underlying stock.

2. Covered Call:

   • Expiration Date: Aim for approximately 30 days to expiration, which offers a balance between premium and distance from the current stock price.

   • Premium: Choose a strike price that generates enough premium to offset the extrinsic value paid for the long call.

   • Delta: Select a strike price with a delta between 0.15 and 0.30. This is an aggressive covered call selection that helps quickly generate a premium. Remember delta can be used as a gauge of probability of being in the money.

   • Number of covered calls to sell: Roughly 50% of the number of covered calls possible.

Why Deep In the Money?

Buying cheaper, at-the-money, or out-of-the-money call options means paying significantly more in extrinsic value. The underlying stock needs to make a more substantial move to become profitable due to the increased breakeven point.

Timing Entries: Tactic 2

This tactic focuses on entering the poor man's covered call when the market is poised for an upward move. It involves identifying specific chart patterns and using the stochastic oscillator.

Continuation Pattern (Uptrend)

• Identified by higher highs and higher lows.

• Enter when the market is making a higher low.

• Confirm that the stochastic oscillator is oversold.

Support Area

• Find previous lows where the market has struggled to break below.

• Enter when the market tests the support area.

• Confirm that the stochastic oscillator is oversold.

Reversal Pattern (Downtrend)

• Identified by lower lows and lower highs.

• Look for the market to attempt to break below a previous low but fail, closing above that low.

• Check the stochastic oscillator for divergence. Price makes a lower low, but the stochastic makes a higher low.

Legging In: Tactic 3

Legging in involves entering the long call and short call separately, rather than simultaneously. This allows for potentially improving the entry price and increasing profits.

• Buy the long call option first.

• Wait for the price to move favorably.

• Sell the covered call after the price movement.

Potential Benefits

• Improved Entry Price: If the market goes up after buying the long call, the covered call can be sold for a higher premium, resulting in a lower net cost.

• Increased Intrinsic Value Gains: By waiting for a price increase, you can sell a covered call at a higher strike price, maintaining the desired premium but allowing for a greater potential profit on the intrinsic value.

Legging Risk

A key risk is that the price may move unfavorably after buying the long call. This could lead to a worse entry price overall. The covered call would need to be sold at a lower premium, resulting in reduced potential profits or even a loss. This risk can be mitigated using Tactic 2: Timing Entries.

By combining legging in with carefully timed entries based on chart patterns and the stochastic oscillator, traders can potentially enhance their poor man's covered call strategy.