Poor Man's Covered Call: How the Trade Works

A poor man's covered call replaces the 100 shares in a covered call with a single deep in the money call option dated a year or more out, then sells a shorter-dated call against it for premium. The long call does the job the stock would do, for a fraction of the cash. The formal name is a long call diagonal spread: two calls on the same stock, different strikes, different expirations.

What is a poor man's covered call, leg by leg?

The long leg is a call with 9 to 24 months of life, struck well below the current share price, chosen with a delta near 0.80 to 0.90. Delta near 0.85 means the contract gains about $0.85 for every $1 the stock gains, which is as close to owning stock as an option gets. Contracts dated that far out are LEAPS, and the deep strikes in particular are the subject of deep in the money LEAPS.

The short leg is a call 20 to 60 days out, struck above the current share price. You take the credit up front. If the stock finishes below that strike at expiration, the contract expires worthless, you keep the credit, and you sell another one against the same long call. That repetition is the income half of the structure.

Why the long call has to sit deep in the money

A call struck near or above the share price moves far less than the stock, and the short call sold against it can outrun it on a rally. The further in the money the long strike, the closer the contract tracks the share price dollar for dollar. A call struck at the money carries a delta near 0.50 by construction, half a dollar of movement for each dollar the shares move, while a strike deep enough to price at 0.85 delta leaves the long leg moving nearly in step with 100 shares.

Depth has a cost on the other side of the trade. Long-dated deep strikes tend to trade in small numbers, and thin volume shows up as a wide gap between the bid and the ask, paid once on the way in and again on the way out. Liquid against thinly traded options covers what that gap costs.

How much capital does it actually save?

The outlay is the price of the long call minus the credit taken in on the short call, set against the full price of 100 shares. The worked example in the next section prices that out with round numbers.

A smaller outlay is not a smaller risk, and it helps to be blunt about that. Shares bought at $100 are still worth $8,000 if the stock falls to $80. A call struck at $80 is worth nothing at $80 on its expiration day. The dollar loss is smaller. The loss on money committed can be total.

The coverage rule most walkthroughs leave out

A real covered call cannot lose on a rally: you already own the shares you might have to deliver. The option version inherits that property only when one inequality holds.

Long strike plus net debit is less than or equal to short strike.

Net debit is what you paid for the long call minus the credit taken in on the short call. Work it with round hypothetical numbers. The stock trades at $100, so 100 shares would cost $10,000.

• Buy the 500-day $80 call at $25.00: a $2,500 debit, of which $20.00 is intrinsic value and $5.00 is time value.
• Sell the 45-day $110 call at $1.50: a $150 credit.

That leaves a net debit of $23.50 per share, $2,350 for the position, or 23.5% of what the shares cost. Run the check: 80 plus 23.50 is 103.50, against a short strike of 110. It clears by $6.50 per share, and that $6.50 is exactly the capped profit.

Here is the position at the short call's expiration, valuing the long call at intrinsic value only. That is a deliberate floor: with more than a year of life left, the long call would still carry time value at every one of these prices, so the real marks sit above these lines.

• Stock at $70: the position is down $2,350, and 100 shares would be down $3,000.
• Stock at $80: down $2,350, and the shares down $2,000.
• Stock at $90: down $1,350, and the shares down $1,000.
• Stock at $100: down $350, and the shares flat.
• Stock at $110: up $650, and the shares up $1,000.
• Stock at $130: up $650, and the shares up $3,000.

Now break the rule. Sell the 45-day $100 call for $3.00 in place of the $110 call. The net debit falls to $22.00, and 80 plus 22.00 is 102.00 against a short strike of 100. The check fails by $2.00 per share. With the stock at $130 at the short expiration, the short call owes $3,000, the long call holds $5,000 of intrinsic value, and unwinding both returns $2,000 against the $2,200 paid: a $200 loss on a $30 rally, from a position that looks covered on the screen. The gap in the inequality is the loss, per share, every time.

The cap is worth pricing as well. $650 on $2,350 committed is 27.7%. The same short call sold against $10,000 of stock, keeping the $150 credit plus $1,000 of share appreciation, is 11.5%. The percentage is larger on the smaller base, and so is the percentage that can go to zero. Covered call return math works the share version denominator by denominator.

Where it stops behaving like a covered call

It collects no dividends

Dividends go to the holder of record of the shares. A call holder is not a shareholder until the call is exercised, so the cash passes by. The panel measures what 6 well-known payers handed 100-share owners over the trailing year.

SELECT
    ticker                                   AS symbol,
    round(sum(toFloat64(cash_amount)) * 100, 2) AS annual_cash_on_100_shares,
    count()                                  AS payment_count
FROM
(
    SELECT
        ticker,
        id,
        any(cash_amount) AS cash_amount
    FROM global_markets.stocks_dividends
    WHERE ticker IN ('AAPL', 'MSFT', 'KO', 'JNJ', 'XOM', 'SPY')
      AND ex_dividend_date >= today() - 365
      AND ex_dividend_date <= today()
    GROUP BY ticker, id
)
GROUP BY ticker
ORDER BY annual_cash_on_100_shares DESC

SPY led the group at $752.5 on 100 shares across 4 payments. A poor man's covered call on that name collects none of it. Dividends also shift the odds of early assignment on the short leg, which ex-dividend dates and options takes apart.

The long leg decays as well

Stock does not expire. The long call does, and the time value inside it drains toward zero along the way. A deep in the money strike carries less time value per dollar committed than a strike closer to the money, which is part of the case for depth, but the amount is not zero and it erodes as the contract ages.

Decay runs fastest in a contract's final weeks and slowest in its early ones, and that shape is the arrangement the diagonal is built on: the short leg sits in the fast stretch, the long leg in the slow one. Every short call sold and expired collects a piece of the fast decay against a long leg giving up the slow kind. How option greeks change over time traces that path contract by contract.

Assignment forces a choice

With the stock above the short strike, the short call can be assigned, and assignment can arrive before expiration rather than at it. You then owe 100 shares you do not have. One route is buying them at the market price, which puts up the capital the structure was set up to avoid. The other is exercising the long call to deliver them, which forfeits every cent of time value still priced into it. Selling a call captures that value; exercising it hands the value back. Early assignment on short options covers when the risk clusters, and the session before an ex-dividend date is the classic case.

FAQ

What is a poor man's covered call?

It is a long call diagonal spread used in place of a covered call: one deep in the money call with a year or more to expiration standing in for 100 shares, with a shorter-dated out of the money call sold against it. The long call supplies the exposure. The short call supplies the premium.

How much capital does a poor man's covered call need?

The outlay is the price of the long call minus the credit from the short call. In the worked example above, a $2,500 long call against a $150 credit commits $2,350 in place of the $10,000 that 100 shares cost, or 23.5% of the share price.

Is a poor man's covered call always covered?

No. It is fully covered only when the long strike plus the net debit is at or below the short strike. When that sum sits above the short strike, a rally past the short strike produces a loss even though a long call nominally backs the short one.

Do you get dividends with a poor man's covered call?

No. Dividends go to the holder of record of the shares, and a call holder is not a shareholder until the call is exercised. The dividend panel above measures what that adds up to in cash on 100 shares over a year.

What happens if the short call is assigned?

You owe 100 shares. You can buy them at the market price, or exercise the long call to deliver them and give up the time value still priced into it. The second route closes out the long leg and ends the structure.

The panel here ships with the exact SQL beneath it. Open it, swap the ticker, and run the same measurement on whatever name you are studying on the Strasmore terminal.