Let's talk about poor man's covered call. What is it? Who is this for?
And when to use it? And as always, I want to show you very specific examples. And the reason why I'm talking about covered calls today is because the poor man's covered call is a very specific type of spread.
And as you know, we have been covering options spreads for the past few sessions. So we actually have a playlist right now that shows you everything that you need to know about options spreads. So here what you see is an option debit spread and this is from a video that I did earlier.
So today I want to talk about a covered call and I want to show you exactly what is the difference between trading stocks, trading a covered call and trading a poor man's covered call, and what is a poor man's covered call. So let's first talk about stocks and I want to use Boeing, BA as an example. So, as you can see, Boeing right now is trading at $180, dead smack.
OK? So let's say that you are bullish on Boeing and that you expect that Boeing will go higher. Let's just say, right?
So this is where many people start with trading stocks, and therefore when trading stocks, you would buy 100 stocks of Boeing and you would buy it right now at $180. So the capital requirements, if you are trying to trade 100 shares of a stock, is here 100 times $180, so this would be $18,000. If you don't have a margin account, so right now, I assume that you have, let's say, a retirement account or not a margin account, so you are buying 100 shares for $180 each, so that would be a capital requirement of $18,000.
Now, let's see what happens if the stock goes up by a whopping $10. If this happens you would make $10 times 100 shares, so you would make $1,000. Making sense?
So if the stock goes up from $180 to $200, you would make $2,000. Super easy to understand. Now, let's say what happens if the stock drops by $10?
Well, what would happen is you lose $1,000. So super easy to understand, and this is what most people do when they start trading, they start trading stocks. And then as they are getting interested in options, the first strategy that most people do is trading covered call.
Now, first of all, let me show you as we are going to Boeing here, let's just say we would buy 100 stocks of Boeing, and let me just go to the analysis. See, super easy to understand, that's what we talked about. If you go from $180 to $190, we are making $1,000.
Here we are making $2,000 and as the stock price goes down, we are losing money. This is what you see here on the screen. Now, if you look at the chart, you might say, "You know what?
I think that Boeing will go up in the long run. But over the next few weeks, looking at the chart here, I don't think that Boeing will go above $200. " Here's why this is important.
For the covered call, you would now say, "OK, I buy 100 stocks at $180, and at the same time, I am selling a 200 call. " And here we would say, you know what? Today is July 8th, so let's say for the next 10 trading days so we would sell one that expires on July 24th.
Now, let me show you exactly what happens when we do this. So I will here add another trade into this for July 24th, I will sell a 200 call. And you see, for the 200 call right now we are getting $4.
50. So the capital requirements, when you do this, when you sell a call against stocks that you own, it is still the same. You don't have to bring more capital to the table.
So it is still $18,000. So what happens if the stock goes up? Now, first of all, as we sell this 200 call, we are receiving $4.
50. Now options trade in 100 packs, so we are receiving $450. So if the stock goes up by $10, we are making the $1,000 that we would make with a single stock, but we also, in addition, we are making $450 the premium that we received for selling the call.
When we sell a call, we receive a premium and that is what we get. So this means that we make a total of $1,450 and you already see the difference here. So by adding a covered call, if the stock goes up by $10, not only do we get the $1,000 from the stock rising, but we also get the premium that we actually receive by selling the call.
So we are increasing our gains by 45%. Now, the same here if it goes up to $200, we are receiving $2,000 plus the $450 so this means we make $2,450. So again, we are making more than we would make if we would only trade the stock.
Now, here's the cool thing. And you know that we have been talking about debit spreads already, so why would you trade a debit spread? Why would you sell a call against stocks?
Well, not only to increase your gains, as you can see here, but also to reduce possible losses, because if the stock, if Boeing goes down to $170, you would lose the $1,000, but you're getting the $450 in premium. Therefore, you're only losing $550. So as you can see, it does make sense to trade a covered call.
This is why many stock traders, the first thing they do when trading options is selling a covered call because you're amplifying your gains and at the same time, you are reducing your losses. So is this making sense thus far? Because I want to show you what the poor man's covered call is, and I want to show you exactly of what are the advantages and disadvantages of having a poor man's covered call.
But I want to make sure that this is helpful. If it is, do me a favor and click on like really quick or just say, "yes" in the comments so that I know that I'm not going too fast or too slow, that I'm actually going at the right speed. So why would you trade a poor man's covered call?
When would you trade it? If you don't have $18,000 in your account. Because you see, this is what is required when you're buying 100 shares of Boeing.
And let's say that in your account, you only have $10,000. How does a poor man's covered call work? Instead of stocks, you can buy an option, and you would buy an option that is deep in the money at a later expiration.
So not at the same expiration because in the long run, again, you think that the stock stays above the current price and moves slightly higher. So we sold the July 24th. The first thing I want to do here is get rid of the shares because instead of the stocks, we want to buy an in the money call.
So that's what we are doing, we are going to the table. We are going out a month or two. So usually it's one to two months out, I choose a little bit less than two months out, so the September and I'm looking at the 110 call.
Now again, right now Boeing is trading at around $180 so why do I go for the 110 call? We want to see a delta of 0. 95.
Because what does it mean? A delta means that if the stock is moving a dollar, the option is moving $0. 95.
And you see the deeper in the money your call, the higher the delta. The delta is usually never one, and I like to have a delta of let's say 0. 95.
So here we don't have exactly 0. 95, so I go for 110 call and this is what we want to buy. So we are buying the 110 call.
As you can see right now, it costs around $71. So let's talk about it. So the poor man's is we are still selling the 200 call, and now we are buying the 100 call with an expiration of September 18th.
Now what are the capital requirements? So we are no longer buying the shares, we're buying the call, and we are buying one call, which is basically for 100 shares, and we are buying this at $71 so this means our capital requirements are $7,100. As you can see, this is a fraction of the cost for buying a stock.
We are still selling the 200 call. But the main difference here is, instead of buying a stock we are buying a call. Now, let's see what happens if the stock goes up from $180 to $190.
And this is where we are going to our risk graph and we see if it goes from $180 to $190 right here, you see that now we would make $1,335. As you can see, this is slightly less than the $1,450 that we would make with a call. Why?
Because again, the option has a delta of 0. 95, so it only moves 95% of the stock. So if the stock moves $10, the option would only be worth $9.
50 more. Is this making sense? Okay, so let's see what happens if the stock goes up to $200, and we're going back to our risk graph here and we see if it goes up to $200, we make $2,320.
You see it right here. So we will make $2,320. So, again, as you can see, not as much as we would make with a covered call, definitely more than we would make with a stock, but you need much less money.
The cool thing is, with a poor man's covered call, you're almost making as much, you make 95% of the money that you would make with a covered call, you would make more money than just having an outright stock, and you need to bring much less capital to the table. OK. Now let's talk about, of course, when the stock is moving against us.
So when the stock is moving against us here and we say it goes down to $170, we would lose $675. So we are losing a little bit more than we would lose with a covered call, but not as much as we would lose if we would only trade the stock. So as you can see thus far, it sounds awesome.
Why wouldn't you trade the poor man's covered call all the time? Why are people trading stocks? Well, that's what I want to show you right now, where the problem is so that you know that there is a downside to this.
I mean, there's always a downside to it. So the problem starts if the stock goes up above the strike price that you're selling, because with the strike price that you're selling, you basically say, I am willing to sell the stocks at $200, right? So if you just have the stock and it goes up to $220, you would make $40 times 100, so you make $4,000.
Nice! Right? I mean, this is assuming that Boeing jumps up to $220.
What does it look like here? Well, again, you are capped because you bought the stock for $180, but you have to sell it at $200. So this is why on the stock if it moves up to $220, you only make $20.
So $20 times 100 is $2,000 for the stock. Plus of course, the $450 this is the premium that you always get so as you can see, it would be $2,450. So you're capped here, meaning that you don't make as much as having the outright stock.
Now with a poor man's covered call, this is very similar to a covered call so you are capped. Let's take a look at this. What is your cap here?
It is $2,320. So let's go back here, and you see it is $2,320. This brings us back to we talked about it, what is a poor man's covered call?
Instead of buying stocks, you would buy a deep in the money call at a later expiration. When should you trade it? If you don't have enough money in your account but you want to trade more expensive shares.
And the important thing is, the idea is that the stock stays above the current strike price and moves slightly higher. Now, here's the deal, this cap that you put on the stock expires in 10 trading days from now, 7/24. Today is July 8th.
So and again, we have two weekends in between. So this is why it expires in ten trading days. So as long as Boeing stays below $200, it definitely makes sense to trade the covered call.
And do you actually lose money if Boeing would go above 200? Do you lose money? No.
The only thing is that you wouldn't make as much money as if you had traded the outright stock. But overall, as you can see, the advantages of trading a covered call, or trading a poor man's covered call, if you're long term bullish on a stock, that's the important thing, if you're long term bullish on a stock, then the advantages of trading a covered call or a poor man's covered call outweigh the disadvantages then trading a stock. And before you trade a covered call, if you don't have any stocks in your portfolio, consider trading a poor man's covered call.
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