Hey traders,
I got a good question from a reader named Geoff that I wanted to dive into a little deeper because it’s a good question that some of you might also be wondering about
Last week, I wrote about how I’m expecting a little “dip and rip” in the markets — a short dip before stocks rip higher again. Then I went on to share several ways to play it using income strategies like covered calls, credit spreads, and naked puts.
Well, Geoff wrote in asking this:
“What are your thoughts about using a Poor Man’s Covered Call to generate income on higher-priced stocks? In what circumstances might you use a PMCC strategy instead of a credit spread?”
This is important, so I want to be pristinely clear with my answer:
I do not like the Poor Man’s Covered Call. In what circumstances would I use it? Never.
Now, let me explain why, because there’s a very good reason I steer clear of the Poor Man’s Covered Call.
What is the Poor Man’s Covered Call?
For those of you who might not be familiar with the term, a Poor Man’s Covered Call (PMCC) is when instead of buying 100 shares of stock, you buy a long-dated option (also known as a LEAP) and sell short-term call options against it to generate income. Sounds good in theory, right? But here’s the problem…
A LEAP is an option that can become worthless.
On the other hand, when you own a stock, it’s an asset. The stock can grow in value, pay a dividend, and give you opportunities to lower your cost basis by selling options against it.
But a LEAP? It does none of that.
It’s a ticking time bomb. Once it expires, if it’s worthless, you’re left with nothing.
That’s the main reason why I don’t like the Poor Man’s Covered Call.
If I’m putting my money on the line, I want to own something real. I want to own the stock, not a piece of paper that could end up worthless in the blink of an eye.
Other Reasons To Avoid the PMCC
There are plenty of other reasons I’d avoid the PMCC. Here are a few more I can think of:
- You’re buying, not selling: With a PMCC, you’re buying an option. Remember, I’ve spent nearly 40 years selling options. It’s the way I trade because it’s what I’ve seen work time and time again.
- Time decay: LEAPs have an expiration date. Stocks don’t. When the LEAP expires, you’re done. With a stock, you can sit on it, sell covered calls, and generate income indefinitely.
- More complicated: I tend to favor simple, proven strategies. The PMCC adds an extra layer of complication because it has more moving parts.
- Cost: The PMCC might appear to cost less on paper, but because that value is all or mostly time value, that value is burning away as time passes. Buying 100 shares of stock is a better investment, in my opinion, because if it’s a good stock, it will retain that value and possibly even grow as the stock appreciates.
Long story short, I like to trade with the odds stacked in my favor, and owning a LEAP is not stacking the odds in your favor. It’s playing a risky, complicated game.
So, while some people might try to make a case for using the Poor Man’s Covered Call, it’s not for me.
Trade well,
Jack Carter
P.S. This market melt-up won’t last! Register to discover how my pal Nate Tucci is working it to his advantage!