I am only going to go over one trade today and will finish up the remaining four Dogs of the Dow trades tomorrow.
The trade today is in International Business Machines (IBM).
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International Business Machines
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, 105 call strike fits the bill.
We can buy one options contract, which is equivalent to 100 shares of IBM, for roughly $33.70, if not slightly cheaper. Remember, always use a limit order – never buy at the ask price, which in this case is $34.35.
If we buy the $105 call strike for $33.70, we are out $3,370, rather than the $13,510 we would spend for 100 shares of IBM. That’s a savings on capital required of 75.1%. Now we can use the capital saved ($10,140) 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 105 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 0.20 to 0.40, or a probability of success between 60% and 85%.
As you can see in the options chain below, the 140 call strike with a delta of 0.35 falls within my preferred range.
We could sell the 140 call option for roughly $2.74.
Our total outlay for the entire position now stands at $30.96 ($33.70 – $2.74). The premium collected is 8.1% over 43 days.
If we were to use a traditional covered call our potential return on capital would be far less than half, or 2.0%.
And remember, the 8.1% 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 IBM 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.
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.