What it is
A covered call with the shares replaced. Instead of buying 100 shares, you buy one call deep in the money with a year or more to run, which moves almost one-for-one with the stock, and sell shorter-dated calls above the price against it, as you would against shares. In this example the long call costs under a quarter of what the shares would.
Formally it is a diagonal spread. "Poor man's" refers to the capital it saves, not to anything about who runs it. The long call is sometimes called a LEAPS, the exchanges' name for options with more than a year to expiry.
What has to happen for it to make money
The stock has to hold up, or rise toward the short call's strike. Near that strike, the short call expires worthless and the long call has gained with the stock, which is the best outcome for the month. A fall costs much as it would on shares, dollar for dollar at first, cushioned only by the short call's premium.
The trade the capital saving buys is leverage: a fall of a given size takes a far bigger share of a smaller stake. On the chart, the worst case at a price of zero is the whole cost of the long call. Rising volatility helps it a little while it is open, because the long call has more time left than the short one.
Once it is on
Each month the short call expires, is bought back, or is rolled, and a new one is sold, as with any covered call. The long call keeps losing a little time value as it ages, and is usually sold and replaced well before its own expiry, while it still behaves like shares.
A rally past the short strike needs care. With shares, assignment simply hands them over. Here there are no shares to hand over: assignment leaves you short 100 shares, covered by a call you would have to exercise, throwing away its remaining time value. Rolling the short call up and out, or closing both, before that happens is the usual answer.
What goes wrong
A steep fall. The long call loses most of its value, and because it was bought with less money, the percentage loss is much larger than on shares, with no dividends received along the way.
Writing the short call too close. The usual check is that the gap between the two strikes is larger than the position's net cost. Then a rally that carries both calls deep into the money still ends with a small gain, as it does in this example; sell the short call much closer and that cushion becomes a locked-in loss.
Pros and cons
- Pro: covered-call income for a fraction of the capital.
- Pro: the loss is limited to the long call's cost.
- Pro: the long call can be written against month after month.
- Con: a fall takes a much larger share of the money put in.
- Con: no dividends, and early assignment is messier than with shares.
- Con: the long call decays and has to be replaced.
In Restrike
The Portfolio folds the two calls into one row, a call diagonal, with both expiries on it, and counts the long call as cover for the short one when it expires no sooner and is struck no lower, so the margin cushion charges the short call nothing, as a broker would. On the Log the long call is its own row and the short calls chain as you roll them; one strategy label across both scores the campaign. Import is read-only, and Restrike never places a trade.