Poor Man’s Covered Call: A Strategy for Small Accounts

Are you a small business owner in need of an affordable business strategy? If so, the Poor Man’s Option Strategy may be your solution. This cost-effective alternative to traditional equity instruments is popular with businesses looking to boost their competitiveness without making significant upfront investments. We’ll explore this viable option in more detail, from understanding how it works, its advantages and disadvantages, and deciding if it’s the right fit for your company. Read on to learn more about this accessible resource!

What Is Poor Man Option Strategy?

A “poor man’s option strategy” is an options trading strategy aimed at replicating the profit potential of a covered call but with reduced capital requirements.

To execute this strategy, investors buy long-term call options on stocks they own or will own in the future and sell short-term call options against long-term calls to generate income. Proceeds from the sale of short-term call options help offset the cost of long-term call options and lower the overall cost of the strategy.

The main advantage of the Poor Man’s option strategy is that it requires less principal than a traditional covered call strategy as it requires the purchase of a long-term call option instead of purchasing the underlying stock. However, this strategy also has some drawbacks, such as potential losses if the stock price drops significantly and the depreciation of short-term call options over time. It is important to note that options trading can be complex and risky, and investors should fully understand the strategy and the risks involved before using it. We recommend that you consult your financial advisor before making any investment decision. 

How Does Work Poor Man Option Strategy? 

The Poor Man’s option strategy works like this:

1. Purchase long-term purchase options

Investors buy long-term call options on stocks they own or plan to own. This gives you the right, but not the obligation, to purchase the underlying shares at a set price (called the strike price) at any time before the option expires.

2. Selling short-term call options

The investor then sells a short-term call option against the long-term call just purchased. These short-term options have lower strike prices than long-term options but expire sooner. By selling these options, the investor receives income in the form of a premium on his chances. 

3. Repeat

The investor can repeat step 2 by selling the short-term call option against the long-term call option held, earning income to offset the cost of the long-term call option.

The idea behind the poor man’s option strategy is that the proceeds from selling short-term call options offset the cost of long-term call options, helping to lower the overall process cost. If the stock price rises, the investor will benefit from the long-term call options purchased, but the short-term call options sold will expire and become worthless. Investors can profit from the income generated by selling short-term call options even if the stock price is flat or declining. Still, potential losses on long-term call options are limited to the premium paid.

It is important to note that this strategy involves trading options. This can be complex and risky. Investors should understand the procedure and the associated risks before using it in trading. 

What Are the Advantages Of Poor Man’s Option Strategy?

The poor man’s option strategy has several advantages.

1. Reduced capital requirements: This strategy allows investors to reduce capital requirements and replicate the potential returns of covered calls. Instead of buying the underlying stock, the investor only needs to buy a long-term call option.
2. Income generation: By selling a short-term call option against a long-term call option, the investor earns income as an option premium. These returns help offset the costs of long-term call options and lower the overall cost of the strategy.
3. Limited risk: Any potential loss from a long-term purchase option is limited to the premium paid for it. This provides protection against losses should the stock price fall.
4. Flexibility: Investors can adjust the strike price of a short-term call option to sell to reflect their expectations of stock price movements better. You can also sell more short-term calling options to generate additional income.
5. Tax benefits: This strategy involves option writes that are classified as capital gains rather than recurring income, which may result in lower taxes for investors.

Overall, the Poor Man’s option strategy can effectively generate income and reduce capital requirements while maintaining upside potential. However, as with any investment strategy, it is essential that you fully understand the associated risks and consult your financial advisor before making any investment decision. 

What Are the Disadvantages Of Poor Man’s Option Strategy?

The Poor Man’s option strategy also has some drawbacks.

1. Limited climbing potential: Since the investor only holds long-term call options, not the underlying stock, the profit potential is limited if the price rises significantly.
2. Time decay: The value of short-term call options sold by investors diminishes over time as they approach expiry. This may reduce the income generated by the strategy and force investors to sell additional short-term call options to maintain income generation.
3. Volatility risk: This strategy may not provide sufficient downside protection if stock prices change significantly and rapidly. This can lead to losses on long-term call options.
4. Margin requirements: Depending on the broker you use, margin requirements may be higher when trading options than when trading stocks. This may increase the capital required to execute the strategy.
5. Complex trading strategies: A poor man’s covered call strategy involves multiple option trades and can be complex for investors unfamiliar with options trading. This can increase your risk of making mistakes or needing to understand your strategy fully.

Overall, an investor should consider the potential risks and drawbacks of Poor Man’s Covered His Call Strategy before using it in trading. You should also consult a financial advisor or experienced options trader to understand the strategy and its risks better. 

Conclusion

To conclude, the poor man option strategy effectively generates wealth and diversifies a portfolio. Creating a combination of short-selling calls, long puts, and cash positions can help investors lower their risk exposure and invest more aggressively with a limited amount of capital. Investors should also consider creating a portfolio of options for their overall financial plan. This strategy can be tailored based on investment goals and liquidity needs. Whether you are an amateur or professional trader, options are always available to increase your return on investment and build wealth. When used correctly with due diligence, the poor man option strategy can provide an investor with the means to continue cultivating financial freedom while mitigating risks they may encounter in the markets.