Anatomy of a Poor Man's Covered Call Strategy (#4 in a Series) #Options #Trading

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Anatomy of a PMCC Strategy

A Poor Man's Covered Call (PMCC) is a versatile options trading strategy that mimics the behavior of a traditional covered call but with less upfront capital. It involves simultaneously purchasing a long-dated, in-the-money (ITM) call option on an underlying stock and selling a shorter-dated, out-of-the-money (OTM) call option against it.

Components of a PMCC Strategy

Long-Dated, In-the-Money (ITM) Call Option: This call option represents the underlying stock position in a traditional covered call. It gives the investor the right, but not the obligation, to buy 100 shares of the stock at a predetermined strike price (the strike price of the long call) on or before the expiration date.

Shorter-Dated, Out-of-the-Money (OTM) Call Option: This call option generates premium income for the investor. It gives the buyer the right, but not the obligation, to buy 100 shares of the stock at a predetermined strike price (the strike price of the short call) on or before the expiration date. The strike price of the short call is typically higher than the current market price of the stock and the strike price of the long call.

Profit Potential of PMCCs

PMCCs can generate income in two ways:

Premium Income from the Short Call Option: The investor receives an upfront premium when they sell the short call option. This premium represents the compensation the buyer is paying for the right to potentially buy the stock at a higher price in the future.

Potential Appreciation of the Underlying Stock: If the underlying stock price rises above the strike price of the short call option before it expires, the buyer will not exercise their right to buy the stock, and the short call will expire worthless. The investor will keep the entire premium they received for selling the short call.

Risk Profile of PMCCs
The downside risk in a PMCC is limited to the premium paid for the long call option. If the underlying stock price declines significantly, the investor may have to pay more for the long call option than the premium they received from selling the short call. However, their loss will be limited to the premium paid for the long call.

Overall, PMCCs offer a capital-efficient way to generate income and profit from an underlying stock while limiting potential losses. They are a suitable strategy for investors who are bullish or neutral on the underlying stock and want to generate consistent income.