Poor Man's Covered Call

A poor man's covered call replaces the 100 shares in a covered call with a deep in-the-money, long-dated call option. You then sell short-term calls against that long call to collect income, capturing most of the covered call's benefit for a fraction of the cost.

It is really a diagonal spread dressed up to mimic owning stock. The nickname says it all: the covered call's payoff, on a budget. Let me show you the swap.

Renting a House You Lease, Not Own

A covered call is like renting out a guest house you own outright. A poor man's covered call is like renting out a house you hold on a long lease. You do not own the property, but your lease gives you nearly the same control, and it cost far less to secure.

The long lease is a deep in-the-money LEAPS call, a call option a year or more out with a low strike. Because it is deep in the money, it moves almost dollar-for-dollar with the stock, acting as a cheaper stand-in for 100 shares. Against that long call, you sell a short-term out-of-the-money call and collect premium, exactly like the rent in a covered call.

Watch It Work

Apple is at $200. A covered call would mean buying 100 shares for $20,000. Instead, you build a poor man's covered call:

• Buy a 1-year $150 call (deep in the money) for $55 a share, or $5,500
• Sell a 30-day $210 call for $3 a share, collecting $300

You control Apple's upside for $5,500 instead of $20,000, and you are already collecting rent.

Apple stays near $200. The $210 call you sold expires worthless. You keep the $300, and your deep long call holds its value. Next month you sell another short-term call and collect again, just like a covered call.

Apple climbs above $210. The short call you sold gains against you, but your long call is gaining too, and it sits far below at the $150 strike, so it more than covers the assignment. Your profit is capped much like a covered call's, above the short strike.

Apple falls. Your long call loses value, as shares would, but you risked $5,500 rather than $20,000, and the premiums you collected cushion the drop.

The Trade-Offs

A poor man's covered call is capital-efficient, but it is not a free lunch.

The upside is obvious: you tie up far less money, freeing capital while still running an income strategy. The leverage of the long call can boost your return on capital.

The catch is that your stand-in is an option, not stock. It carries time decay on the long leg, so you must manage it before the LEAPS expires, and it pays no dividends. You also need to keep the short call's strike above your long call's strike, and mind the width, so an assignment never costs more than the diagonal can cover. It asks for more active management than a plain covered call, in exchange for using far less cash.

Bottom Line

A poor man's covered call is the covered call for a smaller account. Swap the 100 shares for a deep in-the-money LEAPS call, sell short-term calls against it, and you collect the same kind of rent while tying up a fraction of the capital.

The convenience has strings: your stock stand-in is an option that decays and pays no dividends, so it demands more attention and careful strike selection. Handled well, it is one of the most capital-efficient income trades around.

Keep going: the fully funded original is the covered call, and the structure underneath is the diagonal spread.