Are you thinking of selling a poor man’s covered call on stocks to earn more income? if so, you came to the right place. In this article, I’m going to go through the entire process regular investors like you sell covered calls every day.
Another great strategy “Selling put for income“: updated June 2023
Table of Contents
- What to Expect?
- Not a financial advisor
- Intro Selling poor man’s covered call
- What do you need to sell a poor man’s covered call?
- How do covered calls make money?
- Looking at expiration
- Does the dividend affect my poor man’s covered call?
- When it is the right moment to sell a covered call
- Where is the risk?
- Knowing the total return
- Poor man’s covered call at Expiration
- Last words
What to Expect?
Now, this article assumes you already know the basics of options. I’ll cover the following:
a. Generate weekly or monthly income.
b. when it’s the best time to sell poor man’s covered calls.
c. how to make the most money from them and when to close out the trade.
I’ll also go over the risks of selling covered calls. Yes, there’s always a risk and it might not be what you think so stay tuned. Now if you’re new to the trading strategy I suggest starting with this article published just a few months ago.
Not a financial advisor
Disclaimer, this is not investment or financial advice as I’m not a financial advisor or licensed in any way to provide investment advice. also, be aware that past performance does not apply to future results.
I’m an active options trader for nearly 7 years.
This article is just for informational purposes only. not a suggestion to buy or sell.
If you like to learn about investing, or making money. Check my other articles such as “Options trading for beginners“.
Intro Selling poor man’s covered call
You’re here because you want to know more about the upside potential of selling poor man’s options.
When times in the market are tough, the nice thing about selling covered calls on stocks
is that no matter what happens you’ll still be able to sell the option and collect the premium.
Definition – A call option is a contract that investors can buy and sell.
For the purposes of this article, we’re going to be discussing American-style call options. Investors who sell American call options.
It gives the buyer, the right but not the obligation, to buy specific underlying security like a stock,
from the seller at a specific price at any point until the option expires.
covered call
Another type of option is called the European-style option.
It gives the buyer the option to exercise only on the expiration date. we’ll be considering American-style options.
What do you need to sell a poor man’s covered call?
In order to sell a traditional covered call position on the stock you will need two things:
- a margin account.
- brokerage approval for “selling options“.
Approvals might happen automatically, or you might have to request them from your broker.
if you’re looking to sell naked options and this is where you don’t own the underlying security.
Selling naked options comes with theoretical unlimited risk and will likely be harder to get approval for.
Selling covered call option, the risk is very low.
How does a poor man’s covered call make money?
look at how selling a traditional covered call works with an example.
we can search for Tesla in our brokerage account and see it’s trading at around $200.
To find the right option to pick, let’s open the options tab.
here, calls are on the left, and put options are on the right. First, you should pick an expiration date.
for this example, I’ll pick December 2th as it’s about a month into the future from today.
I find that picking an option a month or more into the future,
often gives me a better chance to lock in a profit down.
Here we can see a list of strike prices and the bid price is the price someone is currently willing to pay for the option. so let’s take a look at this slightly out of the money (otm option) the 235-dollar strike that you can sell for 7.25 cents or 725 dollars for one contract.
less any commissions the 725 dollars is the option premium or income that you get to keep regardless of what happens to the direction of the stock.
Looking at expiration
if by December 2th Tesla stock is trading below the strike price of 235 it’ll expire worthless and the 725 dollars is yours to keep. but if it’s trading over 235 up to any point and including the expiration date the buyer can and will likely exercise their right to buy the stocks from you at $235 a piece.
Now that you know the mechanics of an American-style option the part that makes it covered is the fact that you must own at least 100 shares of the underlying security for each option contract. but the number doesn’t have to be round. I mean in this case with Tesla, if you were to sell two contracts you’ll need to already own at least 200 shares.
You can have more like 220 or 260 or whatever but to sell two call option contracts, you’re going to need 200 shares minimum.
Your goal is for the stock to trade below the strike price so that your option expires worthless at expiration.
This way you get to keep your shares and the income you made from selling the option. Later on, I’m going to show you how you can find call options that have an 85 chance or even a 90 percent chance of expiring worthless and you can do it week after week month after month. it’s kind of like getting your cake and being able to eat it too.
Does the dividend affect my poor man’s covered call?
You might be wondering, about the dividend first.
In that case, the company will already be factored into the price of the option.
selling a traditional covered call on it. and if between now and the options expiration a dividend is paid out. The dividend amount might already be factored into the option price. keeping the dividend and the call option income.
and many investors make two even three or times their income by using this strategy it’s called double dipping and if you like the idea of double dipping your income.
Call options are priced based on their intrinsic value. (a few key differences between the strike), the price of the underlying security and the time value. which is the rest of the value both time to expiry and volatility.
When it is the right moment to sell a poor man’s covered call
Investors will make the most money selling call options with longer expiration dates when volatility is high. when volatility is low and the expiration is sooner the option premiums will be a lot less.
Now I wouldn’t blame you if you were wondering how much can you make selling covered calls. well folks it’s not unheard of to get 20% on an annualized basis selling poor man’s covered call options strategy. how much you earn depends on how volatile the stock currently is, the strike, and the expiration date.
In general, when the markets are calmer you’ll have to sell the closer to the money with an expiration date that’s further out. however, the more volatile the markets are the higher the monthly income you’ll earn selling poor man’s covered calls and many call sellers love it when stocks are volatile because even if it means the risk of getting exercise is higher volatility means more income.
Where is the risk?
You might be wondering about the risks. well, there are three parts to it…
Risk No 1 – poor man’s covered call explained
The first risk is that if the underlying equity rises above the strike price. In that case, you’ll be forced to sell. if you’ve owned the stock for a long time you might have a significant capital gainand if your option is exercised. that total gain will be crystallized.
let’s look at Tesla stock again. If you’ve owned it for a while since 2019 when it was trading around $22, you had to sell your stocks today you’d have a couple of hundred dollars in capital gains to deal with at tax time for each call option contract sold and depending on your tax rate this could result in a significant tax burden.
Risk No 2
The second risk is that the stock can falls during your traditional covered call trade.
If that happens, don’t panic! all you need to know is that you’re not going to be able to sell your stock.
first, close out your call option and that’s how you mitigate any call options risk.
Another solution, close out your trade by buying back the exact same option that you initially sold.
your broker might know this as a buy-to-close order either way when you buy back the option you’re going to have to pay for it. it’s going to eat into your profits. in fact, if the stock has risen above the strike price and you want to close out your trade, you might even have to pay more for your option to close out that leg.
but wait it doesn’t have to end there one way to fix the trade and make some more money is to roll the call option. rolling the call option means first buying back the option you originally sold and then you can sell another call option with a slightly higher strike price a little further down the road. it’s kind of like kicking the can until the option expires worthless and you get to keep a hundred percent of the income
Risk No 3 – covered call explained
Early assignment, with American-style options. The call buyer can exercise their right to buy the shares from you at any time before expiration.
While it doesn’t usually happen it might happen. if there’s some surprise where the buyer feels it’s in their best interest to buy the stocks at the strike price. It’s rare but just know that it’s possible.
Goal
The goal of every option seller is to let the option expire worthless. if you’re looking for the best chances of having an option expire worthless.
more than 90 chance the option will expire worthless, keep in mind the earnings dates. stocks tend to be more volatile leading up to and shortly after their earnings call and as a result, your stock rises above the strike price by expiration.
well expect the option to get exercised, for this reason, that’s why I prefer an option that expires at least a week or two after an earnings date.
In order to sell a covered call you’ll first need at least 100 shares of the company in your brokerage account. for each contract, you want to sell. so if you want to sell two contracts at the same time you’re going to need 200 shares of the company and so on.
Knowing the total return
First is the total return and the other is the annualized return. the total return is the amount of the income divided by the stock price rises, that’s it.
back to our Tesla example again, let’s say you got 725 cents for selling the call option and the option expired worthless well your total return is only around 600 now, 600 might not sound fun but what if that was just after a week or a month.
If the call option is exactly four weeks out, calculate the annualized return – is the option income times 52 weeks times 100 divided by the stock price times the number of weeks left for the call option expiration.
In this case, you would get an annualized return of 47.25. it is far more interesting than 7.25 percent. Another thing to consider is the break-even point.
How to calculate The breakeven point? it’s the price you paid for the stock, minus the option premium.
In the Tesla example again the stock was trading around 200 and let’s say you simultaneously bought the stock and you sold the $325 call option. and by doing that you collected 7.25 cents in option premium.
In this case, your breaking break-even point is 192.75, this is probably only important if you bought the shares and sold the call option simultaneously.
Poor man’s covered call at Expiration
You might be wondering about all of the different scenarios that might happen at expiration. At expiration one of three things is going to happen.
- The option is “in the money” meaning the stock is above the strike price. if this happens your shares will get sold to the buyer at the strike price and using the above Tesla example if you sold two contracts at the $200 strike well you’re going to sell your shares.
- The option is “at the money” meaning the stock is the same price as the strike price. in this case, the option will most likely expire worthless and you get to keep your shares and the options income.
- The option is “out of the money” and this is exactly what everybody wants. the stock price ends below the call option strike price. in this scenario, the option expires worthless and you keep your shares and the options income.
Last words
Selling covered calls on stocks can be a genius way to double or even triple your income but don’t get too greedy. Stick to high-quality stocks and those that have a high problem probability of expiring worthless.
This way you can hopefully repeat the process over and over.
Another strategy you may be interested in is: Butterfly strategy
Next topic to cover – P / E Ratio