Note: This involves Risk
You Could Lose Money
These are not day trading and instant gains.
Since @thots_and_prayers mentioned on TF - I thought I try and make a guide which is mostly copy and pasted.
It will use RobinHood as an example please adapt to you’re own broker
Selling Poor Man’s Covered Calls (PMCC) is a great [options] strategy for those with smaller accounts to start generating passive income (premium). [The regular covered call strategy] requires a large amount upfront capital to purchase 100 shares of a stock to sell calls against. PMCCs allow you simulate owning 100 shares by purchasing a deep in-the-money call option, which requires much less upfront money, and selling calls against it which will generate premium. You can then reinvest this earned premium back into your portfolio which, over time, increases the effects of compounding growth. Strategically and successfully employing PMCCs within your portfolio can help it grow at a much quicker rate than simply relying on [dividends ] alone.
I highly recommend you study the [greeks] so you can better understand the risk of an option and to be able to determine an option’s sensitivity to the variables that make up that risk. Do this before you start using the PMCC strategy.
To begin, PMCCs require that you buy a deep in-the-money call with a distant expiration date (long call). The expiration of the call option should be at least 3 months in the future. That deep in-the-money call will serve as your collateral in this options strategy. You want this call option to be on a stock that you are bullish on which, over time, help the value of the call option increase in value. Additionally, the call that you buy should ideally have a delta of at least 0.70. This will help simulate the effect of own 100 shares of the underlying stock without actually having to purchase 100 shares.
Example: Stock ABC currently trades at $100. You buy a call with a strike of $80, an expiration date of 1 year in the future, and with a delta of 0.70. This call option costs you $2500 instead of $10,000 that it would have cost you to buy 100 shares of the stock.
You will then sell out-of-the-money calls with shorter expirations against the call your bought (short call). This simultaneously give the call you bought some downside protection and will generate premium which will help reduce the breakeven price of the call you bought. This out-of-the-money call strike should be above both the strike of the call that you bought and the current price of the stock.
Example: Using the call option that you bought in the previous example, you will now sell calls against it. Stock ABC maintains its $100 price for the next month. You sell a call with a strike of $110 with an expiration of 1 week in the future. This generates $50 in premium. You do this 4 times over the next month and generate a total of $200 in premium which lowers the cost basis of the call option that you bought to $2300.
Each time that you sell a call, you will need to adjust the strike price of the option based on the price of the stock. This will help prevent the option from expiring in-the-money and being assigned.
You must be approved for “Options Level 3” by Robinhood in order to run the PMCC strategy through their brokerage.
- Contract – Each contract represents 100 shares of a stock.
- Strike price – The price at which the contract can be exercised at. For calls, any price at the contract strike price and above can be exercised. For puts, any price at the contract strike price and below can be exercised.
- Expiration date – This is the future date at which the options contract will expire. If the contract is to be exercised, it must be done by this date.
- Premium – This is the amount of money you will be credited to your account for selling the call.
- In-the-money -The stock price is above the strike price.
- At-the-money – The stock price is at the strike price.
- Out-of-the-money – The stock price is below the strike price.
Please do plenty of research and fully understand the risks that you are taking before you trade options. Not doing so can easily end up costing you thousands of dollars. There are a few different risks with the PMCC.
First, is that the stock that you bought the call against dramatically drops in price. This would likely make the long call an out-of-the-money option and make it extremely difficult to sell short calls and avoid assignment.
Second, is that the price of the stock dramatically rises. While this would be great for the value of your long call, your short call would then be in-the-money and in danger of being assigned. If this happens, you can buy to close the short call and sell your long call to cover most if not all the costs.
Robinhood typically will automatically sell your long call to offset the cost of your short call expiring in-the-money. If you simply allow the short call to be assigned you will be responsible for purchasing 100 shares at the strike price you set. The funds to cover this purchase must be in your account, either in cash or margin, or Robinhood will liquidate positions to cover it.
Search for a stock that you want to buy the in-the-money long call on in your portfolio. Look for a high quality company that you are generally bullish on.
I will be using Disney (DIS) for this example. It is a large, stabile company that continue to grow its business year after year. Start by selecting on the “Trade” button.
A menu will pop up after you select the “Trade” button. You can select either “Trade Options” or “Buy”. Select “Trade Options”.
You will then see a screen that looks like the example on the right. Make sure that you have both “Buy” and “Call” selected to start. Next, move the expiration dates at the top of the screen until you get to one that is at least 3 months in the future.
I will be looking at options with an expiration date of “Jan 20,2023” for my long call.
Next, you want to find a strike price that is deep in-the-money and has at least a 0.70 delta. If you touch on the text of the option ($130 Call) then you will see a screen like the example to the right.
DIS is currently trading at $149.30 in this example. I am going to buy a call with a strike at $130 and with an expiration date of 1/20/23. This option has a delta of 0.74. This meets all three metrics for our long call.
If you decide that the option that you are reviewing is the one you want to purchase, select the “+” button. You will see that option button highlight and the + button change to a checkmark.
I have selected the call with the $130 strike. You can see that it says “$30.90” in the highlighted button. That means that I can expect to pay roughly $3,090 to buy this long call. This is dramatically cheaper than the $14,930 it would cost me to purchase 100 shares.
Next, we are going to find your short call. You want to make sure that you have the “Sell” and “Call” buttons selected. You want to look for an option with an expiration date before that of your long call. You also want to find a strike that you feel comfortable will expire out-of-the-money. Once you find the option you want to be your short call, select the “+” button next to it. Now select the bottom of the screen where it says “2 Options Selected”.
I have found an expiration date that is one week in the future (Jan 21) and a strike ($160) that I am fairly certain will expire out-of-the-money. I will be credited 0.22 ($22) in premium to sell this call. According to Robinhood’s algorithm, this option currently has a 92.52% chance of profit, or expiring out-of-the-money.
You will now see a screen that looks like the one to the right. You can now review all the details of your PMCC as well as see a P/L Chart. Once you feel stratified with everything, select the “Review” button. You can the execute the option on the next screen. Congratulations on doing your first PMCC. As the short calls expire, you can continue to sell short calls against your long call until the long call reaches its expiration date. Each short call that you sell will continue to lower the cost basis of your long call.
This PMCC will cost me roughly $3,068. My goal for this PMCC is that I can continue to sell weekly short calls for $20 – $30 in premium each time. Doing this over the course of a year will generate $1,040 – $1,560 and make the long call extremely cheap.
As time passes since doing your PMCC, a few things can happen. If the stock price stays relatively stable, you can continue to sell short calls against your long call until it expires. Over time this will hopefully dramatically reduce the cost basis of the long call and even earn you some money. If the long call reaches expiration, and remains above the strike your selected, you can either sell it or exercise it and buy the stock at the strike.
If the stock price rises, then so will the value of your long call. It is important that you keep the strike price of your short calls above the price of the stock so you don’t risk assignment. If you find your self in danger of assignment, buy to close the short call. You can then sell to close your long call which should cover the expense of buying to close the short call. If you manage to make it to the expiration date of your long call without being assigned, and the stock price has risen dramatically, you can then sell the long call for a nice profit. You can also exercise the contract, if you have enough capital, and buy 100 share of the stock at the strike price.
If the stock price decreases, then so will the value of your long call. If it declines too much then it will become more and more difficult to keep the strike of your short call above the strike of your long call. This makes generating premium difficult. If this continues to happen then your long call will expire out-of-the-money and worthless. This is the worst outcome for the PMCC because you lose 100% of your initial investment.