As I’ve mentioned numerous times in the past, I’m a big proponent of taking a diversified portfolio strategy approach through the use of poor man’s covered calls.
By using poor man’s covered calls, I’m able to reduce my capital outlay by 65% to 85%. And with this reduction in capital, I’m able to realistically diversify my approach over a wide range of strategies. In the past, I’ve discussed my All-Weather portfolio, Dogs of the Dow portfolio, Growth/Value portfolio, Contrarian portfolio, Earnings Yield portfolio and several others.
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But given today’s market environment, I’m going to discuss a strategy known as the Protective Asset Allocation Strategy.
The strategy is proven over the long-term, has a beta of 0.25 and a standard deviation of 9.4%. The goal is to balance risk and returns by investing in different asset classes like equities, fixed income, bonds, international and a variety of others.
I like to use an approach that focuses on a watchlist of 15 highly liquid ETFs that covering a wide variety of asset classes. I then use poor man’s covered calls on the 4 to 6 ETFs with the strongest momentum. Lastly, I look for a potential rebalance every month at the same time. This allows me to keep the focus on momentum without being reactive to shorter-term swings.
However, the protection part comes into play when half of my watchlist reaches a downward trend. Once that occurs, I look towards poor man’s covered puts. But I also move towards bonds and commodities using poor man’s covered calls.
Today, I want to focus on how to build out a portion of the Protective Asset Allocation Strategy using one of the ETFs that reside in the Protective Asset Allocation Strategy during a downtrend.
The SPDR Gold Trust ETF (GLD) is currently trading for 169.96.
I choose my LEAPS call contract by the delta of the option. I prefer to initiate a LEAPS position by looking for a delta of 0.80. With a delta of 0.79, the January 19, 2024, 140 call strike with 711 days until expiration works.
I can buy one options contract, which is equivalent to 100 shares of GLD, for roughly $36.60, if not slightly cheaper. Remember, always use a limit order, never buy at the ask price, which in this case is $37.15.
If we buy the 140 strike call for roughly $36.60, we are out $3,660, rather than the $16,996 I would spend for 100 shares of GLD. That’s a savings on capital required of 78.5%. Now we can use the capital saved ($13,336) to work in other ways, preferably to diversify our poor man’s covered call strategy among other stocks and ETFs.
Once we make the initial LEAPS purchase, we can maintain that position and focus on selling near-term call premium against our LEAPS each month – thereby generating income and lowering the original cost basis with each transaction.
I begin the process of selling shorter-term calls against my LEAPS by looking for an expiration cycle with around 30-60 days left until expiration and then aim for selling a strike with a delta ranging from 0.20 to 0.40, or a probability of success between 60% to 85%.
As you can see in the options chain below, the 175 strike call with a delta of 0.27 falls within my preferred range.
I can sell the 175 call for roughly $1.29.
My total outlay for the entire position now stands at $35.31, or $3,531 ($36.60 – $1.29). The premium collected is 3.5% over 39 days. Not a ton of premium, but remember, we are going out 39 days and using an ETF that has, by most comparisons, a low level of implied volatility (IV).
But remember, if we were to use a traditional covered call our capital outlay would be $16,996 and our return would be 0.08%.
Also, the 3.5%, or roughly 31.5% annually, is just the premium return, it does not include any increases in the LEAPS contract if the stock pushes higher. Since our initial delta is 0.52 (0.79 – 0.27), the LEAPS contract will increase by $0.52 for every dollar GLD moves higher.
The overall delta of the position will eventually hit a neutral state if GLD continues to move higher over the next 30 days. If it does, we simply buy back our short call and sell more premium.
Delta is a major factor in managing poor man’s covered calls. I’m going to continue my ongoing discussion on the Greeks, including delta, theta and gamma over the next several weeks. Stay tuned!
So, as you can see above, we have the potential to create 3.5% every 39 days, or approximately 31.5% a year using a fairly conservative ETF like GLD. This is our baseline and should be our expected return in premium, but again this does not include any capital gains from our LEAPS position if GLD trends higher.
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.