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Poor Man’s Covered Call (KBE)

BTO 1 KBE Jan21 2022 20 strike call (LEAPS) for -10.26 debit
STO 1 KBE Jun19 30 strike call for +1.07 credit
Total cost -9.18 debit
 

The trade has been adjusted as the prices jumped up overnight significantly. We opened the LEAPS call for 10.26 debit and short call for 1.07 credit. Even adjusted trade meets our criteria.
 

Poor Man’s Covered Call (PMCC) trade is a cheap version of a regular buy-write covered call.

When using a covered call you typically buy 100 shares of underlying stock. In a margin account, buying 100 shares of KBE would cost you $1,333.08 (see first picture) if you buy 100 shares at $26.66 a share. Buying 1 call LEAPS contract would only cost you $8.35 dollars. Thus you control 100 shares of a stock for less money. Also, your purchase price (if you decide to exercise your calls) could be less than when you buy at the current market price. In this trade, we selected 20 strike for the LEAPS. There is a reason for it. I will try to explain why I am selecting strikes the way I did.

 
KBE
 

I created a spreadsheet which helps me to quickly calculate metrics I need to see in order to open this trade. The most important metric is the “Initial Setup Criteria” row. This tells me whether the trade is doomed to failure or make money in case it gets assigned right away. The goal of this trade is to own the LEAPS for some time (and eventually make money as the stock goes higher) but if let’s say I open this trade on Monday and on expiration Friday the stock goes above the short call strike, it will get exercised (or if it is exercised early). If this row doesn’t meet the criteria and the trade gets assigned early, you lose money.

 
PMCC KBE
 

So what is this criteria about? It is basically what you get if assigned and that number must be larger than what you paid for LEAPS. If I get assigned, i will receive the difference between the strikes (30 short call minus 20 long call = 10 dollars, or $1,000) plus premium from the short call, in this case 0.35 (or $35). Total premium I would receive would be 10.35 in this trade. We will pay only 9.70 for the LEAPS, so we will get more if we get assigned early than what we paid and thus this trade will be profitable.

Another requirement is that the LEAPS delta needs to be larger than 0.75 so the option price will move as close to the stock price as possible. That is why we chose 20 strike. Another reason was that if we chose 25 strike, the trade initial setup would fail:

The delta would be below 0.75
We would receive less than the cost of LEAPS
You may say, let’s raise the short strike from 30 to 31 or even to 32, but there is almost no premium and it would not help us either. Even with a higher short call strike,m this trade would still be a loser if assigned early or at expiration.

 
PMCC KBE
 
PMCC KBE
 

So, now that I have the strikes selected, and I am happy with the trade, I placed an order for Monday morning. If the short call expires worthless in June 19, we will sell a new call and keep selling calls and lowering our cost basis. Also, if KBE starts going higher, our LEAPS will be making money too. A pre-crash price of KBE was in average at $45 a share, so let’s say, the stock will go up in the next two years and lands on $45 a share. We would be able to sell our LEAPS for $1,834 dollars (intrinsic value between the future price $45 a share, and current price 26.66 a share). Our cost was $7.50, or $750, and thus our profit would be $1,084 on the LEAPS. But let’s say, we manage to sell short calls for average $50 premium every month. That would generate additional $1,000 in premiums in those next two years (I didn’t add the first month and the last three months to the equation as if this trade works, I will roll LEAPS 3 month prior to expiration, so it would be $50 premium x 20 future months). Our total profit would be $2,084. It would be 278% annualized return…

Hope this helped to explain this trade. Let me know, if you have questions.





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