Why the PMCC Is the Professional’s Choice for Covered Call Trading

The Capital Efficient Covered Call Alternative

The Poor Man’s Covered Call (PMCC) is a sophisticated options strategy that mirrors the risk/reward profile of a traditional covered call, yet it is executed with a substantially smaller capital outlay. This approach uses a long-term, deep in-the-money (ITM) call option as a substitute for owning 100 shares of the underlying stock. A shorter-term, out-of-the-money (OTM) call option is then sold against this long call position. The primary function of the PMCC is to generate income through the premium collected from selling the short-term call, which in turn reduces the cost basis of the long-term call option.

This strategy is designed for traders who have a neutral to bullish outlook on a particular stock or ETF. The PMCC offers a way to achieve objectives similar to a covered call ▴ income generation and a defined upside target ▴ without the significant capital commitment of stock ownership.

Professionals gravitate towards the PMCC because of its inherent leverage and capital efficiency. Instead of allocating a large portion of their portfolio to a single stock position, traders can use the PMCC to gain similar exposure with a fraction of the capital. This frees up capital for other opportunities, enhancing portfolio diversification and potential returns. The structure of the PMCC, a long call diagonal debit spread, is what makes this possible.

The long-term call, often a LEAPS (Long-Term Equity Anticipation Securities) option with an expiration of one year or more, mimics the price movement of the underlying stock due to its high delta. The premium received from selling the near-term call provides a steady stream of income, which can be used to offset the cost of the long LEAPS call over time. This dynamic makes the PMCC a powerful tool for traders seeking to optimize their capital allocation while maintaining a bullish stance on a security.

Executing the PMCC with Precision

Deploying the Poor Man’s Covered Call requires a methodical approach to maximize its benefits while managing its unique risks. The process begins with the selection of the underlying asset, which should be a stock or ETF that the trader is bullish on over the long term. The next step is to purchase a deep in-the-money call option with a long-term expiration, typically nine months to a year out. This long call should have a high delta, ideally above 0.80, to closely track the price movements of the underlying stock.

Once the long call is in place, the trader can begin selling shorter-term call options against it. These short calls should be out-of-the-money and have an expiration of 30 to 45 days. The premium collected from the short call generates income and reduces the cost basis of the long call. This process can be repeated each month as the short call expires, creating a consistent income stream.

The core of the PMCC strategy is the substitution of a long-term, deep-in-the-money call option for stock ownership, which can reduce the capital required by as much as 75% compared to a traditional covered call.

Constructing Your PMCC Position

The successful implementation of a PMCC hinges on the careful selection of both the long and short call options. The following table outlines the key parameters to consider when constructing your position:

Managing the PMCC Position

Once the PMCC is established, ongoing management is essential to its success. The primary goal is to have the short call expire worthless, allowing the trader to retain the full premium. This occurs if the stock price remains below the strike price of the short call at expiration. If the stock price rises above the short call’s strike price, the position will need to be managed to avoid assignment.

This can be done by rolling the short call up and out to a higher strike price and a later expiration date. This action will typically result in a credit, further reducing the cost basis of the long call. Conversely, if the stock price falls, the trader can choose to roll the short call down to a lower strike price to collect a larger premium, or simply let it expire worthless and sell a new call for the next expiration cycle. The flexibility of the PMCC allows traders to adapt to changing market conditions and continually optimize their position.

• If the underlying stock price increases, the value of the long call will increase, but the gains will be capped by the short call.
• Should the stock price decrease, both the long and short calls will lose value, but the premium from the short call will help to offset some of the losses on the long call.
• The maximum loss on a PMCC is limited to the net debit paid to enter the position.
• The maximum profit is the difference between the strike prices of the long and short calls, plus the premium received for the short call, minus the premium paid for the long call.

Advanced PMCC Applications and Risk Management

Beyond its basic application as a stock replacement strategy, the PMCC can be adapted for a variety of market conditions and portfolio objectives. For traders with a highly bullish outlook, a more aggressive PMCC can be constructed by selecting a long call with a slightly lower delta and selling a short call that is closer to the money. This will increase the potential return on the position, but also expose it to greater risk. Conversely, for traders seeking a more conservative approach, a PMCC can be structured with a very deep-in-the-money long call and a far-out-of-the-money short call.

This will generate a smaller premium, but also provide a larger buffer against a potential downturn in the stock price. The versatility of the PMCC allows it to be tailored to the specific risk tolerance and market outlook of the individual trader.

Integrating the PMCC into a Broader Portfolio

The PMCC can be a valuable addition to a diversified portfolio, offering a unique combination of income generation, capital efficiency, and bullish exposure. By using the PMCC in place of traditional covered calls, traders can free up capital to invest in other asset classes, such as bonds, commodities, or alternative investments. This can lead to a more balanced and resilient portfolio that is better equipped to weather different market environments.

The income generated by the PMCC can also be used to fund other investment strategies or to provide a steady stream of cash flow for living expenses. When used thoughtfully and in conjunction with other strategies, the PMCC can be a powerful tool for achieving long-term financial goals.

Risk Considerations for the PMCC

While the PMCC offers many advantages, it is not without its risks. The most significant risk is a sharp decline in the price of the underlying stock, which would cause the value of the long call to decrease. Although the premium from the short call can help to offset some of this loss, it may not be enough to prevent a net loss on the position. Another risk to consider is the impact of changes in implied volatility.

A decrease in implied volatility will generally hurt the value of the long call, while an increase will benefit it. Traders should be aware of the implied volatility environment before entering a PMCC and be prepared to adjust their position accordingly. Finally, the risk of early assignment on the short call should not be overlooked, especially as the expiration date approaches. While this is less common for out-of-the-money options, it can still happen, and traders should have a plan in place to manage this scenario.

The Path to Strategic Mastery

The Poor Man’s Covered Call is more than just a capital-efficient trading strategy; it represents a shift in mindset from a passive investor to an active market participant. By understanding and implementing the PMCC, traders can take greater control over their portfolios, optimize their capital allocation, and generate consistent income streams. The journey to mastering the PMCC is one of continuous learning and adaptation, but the rewards can be substantial. For those willing to put in the effort, the PMCC can be a gateway to a more sophisticated and profitable approach to the markets.