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Protective Puts and The Poor Man's Covered Call

02/12/2020 9:21 am EST

Focus: OPTIONS

Alan Ellman

President, The Blue Collar Investor Corp.

Learn the benefits of “The Poor Man’s Covered Call,” with a protective put kicker, from Alan Ellman.

The Poor Man’s Covered Call (PMCC) is a covered call writing-like strategy where the underlying security is a LEAPS (Long Term Equity Anticipation Security) options (1 -2 years expirations) rather than the stock itself. The technical term is a long call diagonal debit spreadSince the cost of the option is lower than the price of the stock, the return on capital (ROC) is higher. On the other hand, we must be comfortable accepting a long-term commitment to a particular stock. The initial trade set-up formula must meet the following criteria:

[(Difference between strikes) + (initial short call premium)] > Cost of the LEAPS option

This ensures that if the price of the stock accelerates exponentially, we can close both positions (long and short calls) at a profit. The first tab of the BCI PMCC Calculator facilitates proper trade entry.

In July 2019, a subscriber named Sunny shared with me a PMCC trade he executed with SPDR Gold Shares (GLD) where he added a protective put component to this PMCC trade. I agreed that this is a sensible approach and so I was inspired to write this article.

Sunny’s trade

  • July 22, 2019: With GLD trading at $134.47, Sunny bought the January 2020 120 LEAP call at $16.10 and the 120.00 protective put at 32¢
  • July 22, 2019: Sell-to-open the Aug. 16, 2019 $136 covered call at $1.75

Initial trade calculations without the protective put 

poor man's covered call calculations

PMCC Trade with GLD without a Protective Put

The initial trade meets our required formula with an initial credit of $1.65 if the trade is forced to be closed early. The initial 1-month return (ROO) is 10.87% with an additional 9.50% of upside potential. These returns highlight the benefit of using a low-cost substitute for stocks in the form of the LEAPS option. We must also keep in mind the disadvantages of employing this strategy (detailed in my book, Covered Call Writing Alternative Strategies, co-authored by me and Barry).

Initial trade calculations with the protective put 

covered call writing calculations

PMCC with Protective Put

The cost of the protective put was so far out-of-the-money that the cost impacted the initial returns minimally. We change the cost of the LEAPS from $16.10 to $16.42 by adding in the cost of the protective put. The initial trade meets our required formula with an initial credit of $1.33 if the trade is forced to be closed early. The initial one-month return (ROO) is 10.66% with an additional 9.32% of upside potential.

Discussion

Adding a protective put component to the PMCC strategy will protect against a catastrophic decline in share value at a very low cost. When entering the cost of the LEAPS, we add the cost of the protective put and then use the PMCC Calculator to monitor our trades.

Use the multiple tab of the Ellman Calculator to calculate initial option returns (ROO), upside potential (for out-of-the-money strikes) and downside protection (for in-the-money strikes). The breakeven price point is also calculated. For more information on the PCP strategy and put-selling trade management click here and here.

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