This article explores a unique approach to trading poor man's covered calls, focusing on identifying resistance levels rather than relying solely on delta values for selecting short call option strike prices. It will cover setting up the strategy, adjustments, and an illustrative example using Nvidia.
Understanding the Poor Man's Covered Call
A poor man's covered call is a strategy that mimics a traditional covered call (owning 100 shares of stock and selling a call option against it) but uses a long-term, in-the-money call option (LEAPS) instead of owning the shares outright. This significantly reduces the capital outlay required.
The Common Delta-Based Approach
The conventional wisdom, often seen on YouTube, suggests buying a LEAPS call option with a delta around 70. The contention arises when selecting the strike price for the near-term call option to sell. Most advocate selling a call option with a delta between 20 and 35, typically around 30. This article argues against this delta-centric view.
Why Resistance Matters More Than Delta
The core argument is that the market doesn't care about delta. Delta fluctuates constantly, whereas support and resistance levels are more stable and provide concrete points where a stock is likely to encounter obstacles.
A Driving Analogy: Stop Signs vs. Speed Bumps
Imagine crossing a road. Would you cross at a speed bump or a stop sign? The stop sign, where cars must stop, is the safer choice. Similarly, selling a call option at a resistance level provides a higher probability of the stock struggling to surpass that price.
Selling at Resistance: A Market "Stop Sign"
Instead of blindly following the delta, this strategy emphasizes identifying resistance levels on the stock's chart. Selling a call option at or near resistance creates a situation where the market is more likely to prevent the stock from exceeding that strike price, leading to potentially more profitable outcomes.
Nvidia Example: Setting Up and Adjusting a Poor Man's Covered Call
The article demonstrates the strategy with a real-world example in Nvidia (NVDA).
Initial Setup
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Date: February 3rd
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Analysis: The stock had recently made a new lower low, suggesting potential for upward movement.
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Long Call Option: Purchased a call option expiring in approximately 11 months with a strike price of $100.
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Short Call Option: Sold a call option expiring in approximately two weeks with a strike price of $117.
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Rationale: Short call option was sold "at the money" due to the new lower low.
Adjustments and Rolls
The Nvidia position required multiple adjustments due to its volatility:
- First Roll: After a 13% price surge, the short call option was rolled up to the $122 strike price for a minimal credit, prioritizing maintaining the benefit of the long call option.
- Second Roll: As Nvidia retraced, the short call option was rolled down to the $115 strike price, collecting a substantial premium due to the stock now being in a downtrend.
- Third Roll: As Nvidia declined further and approached the bottom of a trading channel, the short call option was rolled down to the $105 strike price, anticipating a bounce.
- Fourth Roll: Recognizing a potential trend reversal and a new higher low, the short call option was aggressively rolled up to the $120 strike price, coinciding with the top of the existing trading channel. To offset the cost of rolling the short call up $15, a bull put credit spread was sold.
Results
Despite the roller coaster ride with Nvidia, the strategy proved profitable. As of the filming date, the position had collected over $1,745 in premium against an initial investment of $2,790. If closed out at that time, the position would yield a 37% return, significantly outperforming the stock's 14% price appreciation during the same period.
Recap: Key Steps to Successful Poor Man's Covered Calls
- Buy a Long-Term Call Option (LEAPS): Aim for a delta around 70.
- Sell a Near-Term Call Option: Target an expiration of 30-60 days.
- Focus on Resistance: Sell the call option at or near a resistance level, regardless of the delta.
- Manage the Position: If the short call option goes in the money, consider using strategies like selling cash-secured puts or bullish put spreads to fund rolling the short call option up and out in time.
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