Okay, here is the last installment of my Dogs of the Dow trades for 2022. My hope is that you now have a sound understanding as to how I use the poor man’s covered calls strategy. If you have any questions, please feel free to post them in the comments section below.
As I said in my first installment back on Tuesday, at the beginning of every calendar year I make any necessary adjustments needed for my longer-term poor man’s covered call (long diagonal debit spread) portfolios. I follow numerous proven investment strategies introduced by the likes of Ray Dalio, James O’Shaugnessy, Martin Zweig, Wayne Thorp and numerous other strategists. But more importantly, I use poor man’s covered calls (and poor man’s covered puts when necessary) to increase my probability of success and lower my cost of capital. This allows me to effectively diversify my approach across numerous investment strategies while simultaneously increasing my opportunity for a greater return on capital over the long-term.
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Inherently, the strategy performs well in bullish, neutral and even slightly bearish market environments. Of course, true diversification comes through the simultaneous use of a variety of different options strategies that excel in different market environments (bullish, bearish, neutral).
As an individual investor, make a concerted effort to learn how to use a variety of option strategies and you will have the ability to make money in any type of market environment.
Merck (MRK)
I choose my LEAPS call contract by the delta of the option. It’s a far more simplistic, but effective, way to choose an appropriate LEAPS strike. I prefer a delta around .80. With a delta of .83, the January 19, 2024 60 call strike fits the bill.
We can buy one options contract, which is equivalent to 100 shares of MRK, for roughly $20.00, if not slightly cheaper. Remember, always use a limit order – never buy at the ask price, which in this case is $21.10
If we buy the $60 call strike for $21.10, we are out $2,110, rather than the $7,883 we would spend for 100 shares of MRK. That’s a savings on capital required of 73.2%. Now we can use the capital saved ($5,773) to work in other ways, preferably to diversify our poor man’s covered call strategy among other stocks or ETFs.
After we purchase our LEAPS call option at the 60 strike, we then begin the process of selling calls against our LEAPS.
My preference is to look for an expiration cycle with around 30-60 days left until expiration and then aim for selling a strike with a delta ranging from .20 to .40, or a probability of success between 60% and 85%.
As you can see in the options chain below, the 82.5 call strike with a delta of 0.29 falls within my preferred range.
We could sell the 82.5 call option for roughly $1.14.
Our total outlay for the entire position now stands at $19.96 ($21.10 – $1.14). The premium collected is 5.7% over 43 days.
If we were to use a traditional covered call our potential return on capital would be far less than half, or 1.4%.
And remember, the 5.7% is just the premium return, it does not include any increases in the LEAPS contract if the stock pushes higher. Moreover, we can continue to sell calls against our LEAPS position for another 8 – 12 months, thereby generating additional income or lowering our cost basis even further.
As with our other poor man’s covered call trades, if you are a bit more bullish on MRK stock, you can buy two LEAPS for every call sold. This way you can benefit from the additional upside past your chosen short strike, yet still participate in the benefits of selling premium.
Regardless of your approach, you can continue to sell calls against your LEAPS as long as you wish. Whether you hold a position for one expiration cycle or 12, poor man’s covered calls give you all the benefits of a covered call for significantly less capital.
Amgen (AMGN)
I choose my LEAPS call contract by the delta of the option. It’s a far more simplistic, but effective, way to choose an appropriate LEAPS strike. I prefer a delta around .80. With a delta of .79, the January 19, 2024 175 call strike fits the bill.
We can buy one options contract, which is equivalent to 100 shares of AMGN, for roughly $55.70, if not slightly cheaper. Remember, always use a limit order – never buy at the ask price, which in this case is $57.50.
If we buy the $175 call strike for $55.70, we are out $5,570, rather than the $22,517 we would spend for 100 shares of AMGN. That’s a savings on capital required of 75.1%. Now we can use the capital saved ($16,947) to work in other ways, preferably to diversify our poor man’s covered call strategy among other stocks or ETFs.
After we purchase our LEAPS call option at the 175 strike, we then begin the process of selling calls against our LEAPS.
My preference is to look for an expiration cycle with around 30-60 days left until expiration and then aim for selling a strike with a delta ranging from .20 to .40, or a probability of success between 60% and 85%.
As you can see in the options chain below, the 230 call strike with a delta of .39 falls within my preferred range.
We could sell the 230 call option for roughly $4.75.
Our total outlay for the entire position now stands at $50.95 ($55.70 – $4.75). The premium collected is 8.5% over 43 days.
If we were to use a traditional covered call our potential return on capital would be far less than half, or 2.1%.
And remember, the 8.5% is just the premium return, it does not include any increases in the LEAPS contract if the stock pushes higher. Moreover, we can continue to sell calls against our LEAPS position for another 8 – 12 months, thereby generating additional income or lowering our cost basis even further.
Chevron (CVX)
I choose my LEAPS call contract by the delta of the option. It’s a far more simplistic, but effective, way to choose an appropriate LEAPS strike. I prefer a delta around .80. With a delta of .79, the January 19, 2024 95 call strike fits the bill.
We can buy one options contract, which is equivalent to 100 shares of CVX, for roughly $31.60, if not slightly cheaper. Remember, always use a limit order – never buy at the ask price, which in this case is $33.00.
If we buy the $95 call strike for $31.60, we are out $3,160, rather than the $12,326 we would spend for 100 shares of CVX. That’s a savings on capital required of 75.1%. Now we can use the capital saved ($9,166) to work in other ways, preferably to diversify our poor man’s covered call strategy among other stocks or ETFs.
After we purchase our LEAPS call option at the 95 strike, we then begin the process of selling calls against our LEAPS.
My preference is to look for an expiration cycle with around 30-60 days left until expiration and then aim for selling a strike with a delta ranging from .20 to .40, or a probability of success between 60% and 85%.
As you can see in the options chain below, the 130 call strike with a delta of .26 falls within my preferred range.
We could sell the 130 call option for roughly $1.45.
Our total outlay for the entire position now stands at $30.15 ($31.60 – $1.45). The premium collected is 4.6% over 43 days.
If we were to use a traditional covered call our potential return on capital would be far less than half, or 1.2%.
And remember, the 4.6% is just the premium return, it does not include any increases in the LEAPS contract if the stock pushes higher. Moreover, we can continue to sell calls against our LEAPS position for another 8 – 12 months, thereby generating additional income or lowering our cost basis even further.
3M (MMM)
I choose my LEAPS call contract by the delta of the option. It’s a far more simplistic, but effective, way to choose an appropriate LEAPS strike. I prefer a delta around .80. With a delta of .77, the January 19, 2024 140 call strike fits the bill.
We can buy one options contract, which is equivalent to 100 shares of MMM, for roughly $44.00, if not slightly cheaper. Remember, always use a limit order – never buy at the ask price, which in this case is $44.90.
If we buy the $140 call strike for $44.00, we are out $4,400, rather than the $17,800 we would spend for 100 shares of MMM. That’s a savings on capital required of 75.3%. Now we can use the capital saved ($13,400) to work in other ways, preferably to diversify our poor man’s covered call strategy among other stocks or ETFs.
After we purchase our LEAPS call option at the 140 strike, we then begin the process of selling calls against our LEAPS.
My preference is to look for an expiration cycle with around 30-60 days left until expiration and then aim for selling a strike with a delta ranging from .20 to .40, or a probability of success between 60% and 85%.
As you can see in the options chain below, the 185 call strike with a delta of .29 falls within my preferred range.
We could sell the 185 call option for roughly $2.20.
Our total outlay for the entire position now stands at $41.80 ($44.00 – $2.20). The premium collected is 5.0% over 43 days.
If we were to use a traditional covered call our potential return on capital would be far less than half, or 1.2%.
And remember, the 5.0% is just the premium return, it does not include any increases in the LEAPS contract if the stock pushes higher. Moreover, we can continue to sell calls against our LEAPS position for another 8 – 12 months, thereby generating additional income or lowering our cost basis even further.
As always, if you have any questions, please do not hesitate to email me or post a question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.