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It's fantastic that you're looking to explore the "Poor Man's Covered Call" (PMCC) strategy on Charles Schwab! This is a really insightful approach to options trading, allowing for similar benefits to a traditional covered call but with a significantly lower capital outlay. It's a bit more advanced than simply buying stocks, so let's break it down step-by-step.
The Poor Man's Covered Call: A Capital-Efficient Income Strategy
The Poor Man's Covered Call (PMCC) is an options strategy that synthetically replicates a traditional covered call. Instead of buying 100 shares of a stock (which can be very expensive!), you purchase a long-term, deep in-the-money (ITM) call option on that same stock. This long-term call acts as your "proxy" for owning the shares. Then, against this long call, you sell a shorter-term, out-of-the-money (OTM) call option to generate income.
This strategy is often referred to as a "diagonal debit spread" because you are buying and selling options with different strike prices (diagonal) and different expiration dates (diagonal). You pay a net debit to enter the trade, hoping to profit from the time decay of the short option and the appreciation of the underlying asset.
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| How To Execute A Poor Man's Covered Call On Charles Schwab |
Understanding the Components
Before we dive into the "how-to," let's quickly clarify the two core components:
Tip: Check back if you skimmed too fast.
- The Long LEAP Call (Long-Term Equity Anticipation Security): This is the foundation of your PMCC. You'll buy a call option with a far-out expiration date (typically 6 months to 2 years or more) and a deep in-the-money strike price. The goal here is for this option to behave as much like 100 shares of stock as possible, meaning it should have a high Delta (ideally 0.70 or higher). A higher delta indicates that for every $1 move in the underlying stock, your LEAP will move approximately $0.70 or more.
- The Short Call: This is the income-generating leg. You'll sell a call option with a much closer expiration date (weekly or monthly) and an out-of-the-money strike price. You collect premium from selling this option. The hope is that this short call expires worthless, allowing you to keep the premium and sell another short call in the next expiration cycle.
Now, let's get you set up on Charles Schwab!
Step 1: Are You Ready? Confirm Your Charles Schwab Account & Options Approval Level
Before we even think about placing a trade, let's make sure your Charles Schwab account is ready for options trading!
This is crucial. Options trading, especially strategies like the PMCC, involves specific risks and requires a certain level of approval. If you've never traded options before, you'll need to apply for options trading privileges on your Schwab account.
QuickTip: Keep going — the next point may connect.
Sub-heading: Checking Your Options Approval Level
- Log in to your Charles Schwab account: Head over to the Schwab website or open your StreetSmart Edge® platform.
- Navigate to Account Services: Look for a section related to "Account Management," "Service," or "Account Settings."
- Find Options Trading: Within Account Services, you should see an option related to "Trading Privileges" or "Options Trading." Click on it.
- Verify Your Level: Charles Schwab categorizes options approval into various levels (typically Level 0 to Level 3 or higher). For a Poor Man's Covered Call, which is a type of spread, you will likely need at least Level 2 or Level 3 approval. This typically allows for multi-leg strategies.
- If you are not approved for the necessary level, you will need to apply. The application usually involves answering questions about your trading experience, financial situation, and risk tolerance. Be honest in your answers. Schwab needs to ensure you understand the risks involved. It might take a few business days for your application to be reviewed and approved.
Step 2: Research and Select Your Underlying Asset
This is where the real work begins! Choosing the right stock or ETF for your PMCC is paramount to its success.
Sub-heading: Key Considerations for Underlying Selection
- Stability and Moderate Bullish Outlook: The PMCC performs best on stocks that you believe will either trade sideways or have a moderate bullish bias over the long term. Avoid highly volatile or speculative stocks, as rapid price swings can quickly turn a profitable trade into a loss.
- Liquidity: Ensure the stock and its options are highly liquid. This means there's a lot of trading volume and tight bid-ask spreads for both the stock and its options. High liquidity makes it easier to enter and exit trades at fair prices. Look for open interest and volume on the options chain.
- Dividend Impact (Minor but Note): Unlike a traditional covered call where you own the shares and receive dividends, with a PMCC, you do not receive dividends. This is a trade-off for the capital efficiency.
- Company Fundamentals: Do your due diligence on the company. Is it financially sound? Does it have a good growth outlook? The better the underlying company, the more comfortable you'll be holding the long LEAP.
Sub-heading: Utilizing Charles Schwab's Research Tools
Charles Schwab offers excellent research tools to help you identify suitable candidates:
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- Stock Screener: Use Schwab's stock screener to filter companies based on financial metrics, analyst ratings, and industry.
- Options Chain Analysis: Once you have a potential underlying, go to its options chain.
- Look at the volume and open interest for various strike prices and expiration dates. High numbers indicate good liquidity.
- Examine the Implied Volatility (IV). Lower IV is generally preferable for selling options, as it means less premium but also less risk of rapid, unpredictable moves.
- News and Analyst Reports: Read up on recent news and analyst reports for the company to understand its current situation and future prospects.
Step 3: Identify and Purchase Your Long LEAP Call Option
This is the "Poor Man's" part of the strategy, as it replaces the expensive stock ownership with a more affordable, yet still effective, options contract.
QuickTip: Skim fast, then return for detail.
Sub-heading: Characteristics of a Good LEAP
- Deep In-The-Money (ITM): Aim for a strike price that is well below the current stock price. This ensures a high Delta (ideally 0.70 or higher, with 0.80+ being even better). A high delta means the LEAP's price will closely track the underlying stock's price movements.
- Example: If a stock is trading at $100, you might look for a LEAP with a $70 or $80 strike price.
- Long Expiration Date: Select an expiration date that is at least one year out, preferably two years or more. The longer the expiration, the less susceptible your LEAP will be to time decay (theta decay), which is a key advantage. You want to give the underlying stock ample time to appreciate.
- Liquidity: As mentioned before, ensure there's good volume and open interest for the specific LEAP contract you're considering. Wide bid-ask spreads can eat into your profits.
Sub-heading: Placing the LEAP Order on Charles Schwab
- Go to the "Trade" tab: In your Schwab platform (e.g., StreetSmart Edge® or the web platform), navigate to the "Trade" section.
- Select "Options": Choose the "Options" trading interface.
- Enter the Underlying Symbol: Type in the ticker symbol of the stock you've chosen.
- Find Your LEAP:
- On the options chain, filter by expiration date to find the long-term expirations (e.g., JAN 2026, JAN 2027).
- Locate deep ITM call strikes.
- Select the LEAP Call: Click on the "Bid" or "Ask" price of the specific LEAP call option you want to buy. This will pre-populate an order ticket.
- Set Order Details:
- Action: Buy to Open
- Quantity: Typically, 1 contract (representing 100 "synthetic" shares).
- Order Type: A Limit Order is highly recommended. This allows you to specify the maximum price you're willing to pay. Market orders can lead to unfavorable fills, especially with wider bid-ask spreads on LEAPs.
- Time in Force: Day or Good 'Til Canceled (GTC). GTC orders will remain active until filled or canceled.
- Review and Place Order: Double-check all details carefully before confirming and placing your order.
Step 4: Identify and Sell Your Short Call Option
Once your long LEAP is filled, you're ready to sell calls against it to generate income. This is the "covered" part of the PMCC.
Sub-heading: Characteristics of a Good Short Call
- Out-Of-The-Money (OTM): Choose a strike price that is above the current stock price. This provides some room for the stock to move up without the short call going in-the-money and risking assignment.
- Short Expiration Date: Select an expiration date that is relatively close, typically 30-45 days out. This maximizes time decay (theta decay) which is beneficial for options sellers. Weekly options can also be used for more frequent income, but require more active management.
- Delta Considerations: Look for a short call with a lower Delta, generally between 0.20 and 0.40. This suggests a lower probability of the option expiring in-the-money.
- Premium Amount: Consider the premium you'll receive. You want a decent premium to make the trade worthwhile, but not so high that it indicates excessive implied volatility and risk.
Sub-heading: Placing the Short Call Order on Charles Schwab
- Go to the "Trade" tab and "Options" section: Same as before.
- Enter the Underlying Symbol: Again, the same stock.
- Find Your Short Call:
- Filter by the desired shorter-term expiration date (e.g., next monthly expiration).
- Locate OTM call strikes.
- Select the Short Call: Click on the "Bid" or "Ask" price of the specific short call option you want to sell.
- Set Order Details:
- Action: Sell to Open
- Quantity: 1 contract (to "cover" your 1 LEAP, effectively simulating 100 shares).
- Order Type: A Limit Order is essential here. You want to receive at least a specific amount of premium.
- Time in Force: Day or GTC.
- Review and Place Order: Carefully review everything! You are now opening a spread, so ensure both legs are correct.
Step 5: Monitoring and Managing Your PMCC
The Poor Man's Covered Call is not a "set it and forget it" strategy. Active management is key to maximizing profits and mitigating risks.
Sub-heading: Regular Monitoring
- Track Stock Price: Keep a close eye on the underlying stock's price action relative to your short call's strike price.
- Monitor Short Call Premium: As the expiration date approaches, the time value of your short call will decay.
- Check Delta of LEAP: Ensure your LEAP's delta remains high. If the stock drops significantly, the LEAP might become less effective as a stock proxy.
Sub-heading: Managing the Short Call Leg (Rolling)
- If the Short Call is Out-of-the-Money (OTM) at Expiration: This is the ideal scenario! The short call expires worthless, you keep the full premium, and you can simply sell a new short call for the next expiration cycle.
- If the Short Call is At-the-Money (ATM) or Slightly In-the-Money (ITM) near Expiration: This is where you'll typically roll the short call.
- Roll Out: Buy back your existing short call (to close it) and sell a new short call with a later expiration date (e.g., next month). This gives the stock more time to move in your favor or simply allows you to collect more premium.
- Roll Up (and Out): If you're still bullish, you can roll to a higher strike price in addition to a later expiration. This caps your upside at a higher level, but you'll likely receive less premium for the higher strike.
- Roll Down (and Out): If the stock has pulled back but you remain moderately bullish, you might roll to a lower strike price for a later expiration. This collects more premium but increases the likelihood of the short call going ITM.
- If the Short Call is Deep In-the-Money (ITM) and You Expect Continued Upside: You may consider buying back the short call to close it and not immediately selling another. This allows your long LEAP to capture more of the stock's upside, though you forgo the immediate income. You could then re-evaluate selling a call later.
- Assignment: While less common with PMCCs if managed correctly, if your short call is deep ITM at expiration and you don't roll it, you could be assigned. With a PMCC, if assigned, your long LEAP would be automatically exercised to cover the assignment, effectively closing out your spread. Be aware of the fees associated with exercise/assignment on Schwab.
Sub-heading: Managing the Long LEAP Leg
- Time Decay: As your LEAP approaches its expiration date (typically with 6-9 months remaining), time decay will accelerate.
- Roll Out the LEAP: To maintain your PMCC, you'll eventually need to "roll" your LEAP. This means selling your existing LEAP and buying a new, even longer-dated LEAP with a similar or deeper ITM strike. This ensures you continue to have a long-term synthetic stock position. This often involves realizing a gain or loss on the original LEAP.
- Adjusting Strike Price: If the stock has moved significantly, you might consider rolling your LEAP to a different strike price to adjust your exposure.
- If the stock has rallied a lot, you could roll your LEAP to a higher strike (locking in some gains on the original LEAP) while still maintaining a deep ITM position.
- If the stock has dropped significantly, you might roll your LEAP to a deeper ITM strike (potentially for a debit) to maintain a higher delta.
Step 6: Exiting the Poor Man's Covered Call
Knowing when and how to exit the entire position is as important as initiating it.
QuickTip: Note key words you want to remember.
Sub-heading: Closing Both Legs Simultaneously
The most straightforward way to exit a PMCC is to close both the long LEAP and the short call simultaneously.
- Create a Multi-Leg Order: On Charles Schwab, you can typically create a "spread order" or "multi-leg order" to close both legs at once.
- Actions: You will Sell to Close your long LEAP and Buy to Close your short call.
- Net Credit/Debit: The platform will show you the net credit or debit for closing the entire spread.
- Limit Order: Always use a Limit Order to control your exit price.
Sub-heading: Considerations for Exiting
- Profit Target Reached: If the stock has performed as expected and you've collected sufficient premiums, you might decide to close the position and take your profits.
- Max Loss Approaching: If the stock moves significantly against you and your LEAP is losing substantial value, it's prudent to cut your losses before they escalate further.
- Change in Outlook: If your fundamental outlook on the underlying stock changes (e.g., you become bearish), you should consider exiting the PMCC.
- LEAP Expiration: As your LEAP approaches its final expiration, you'll need to decide whether to roll it out to a new LEAP, or close the entire position.
Important Considerations & Risks
While the PMCC offers capital efficiency, it's not without its risks:
- Capital at Risk: You can still lose 100% of the premium paid for your long LEAP if the underlying stock drops significantly and your LEAP expires worthless.
- Limited Upside Potential: Just like a traditional covered call, your potential profit is capped at the strike price of your short call plus the net credit received from the premium, until you roll the short call to a higher strike.
- Assignment Risk: If the stock rallies sharply and your short call goes deep in-the-money, you risk assignment. While your LEAP can cover this, it still incurs transaction costs and may force an early closure.
- Liquidity Risk: If the options for your chosen stock are illiquid, you might face wider bid-ask spreads, making it harder to enter or exit trades at favorable prices.
- Time Decay (Long LEAP): While slower than short-term options, your LEAP still experiences time decay. You need the stock's appreciation to outpace this decay to be profitable.
- Complexity: PMCCs are more complex than simply buying stock or even a single call option. They require a good understanding of options Greeks (Delta, Theta, Gamma, Vega) and active management.
- Tax Implications: The tax treatment of options can be complex. Consult with a tax professional regarding how your PMCC trades will be taxed (e.g., short-term vs. long-term capital gains/losses).
10 Related FAQ Questions
Here are 10 frequently asked questions about Poor Man's Covered Calls, with quick answers:
How to choose the best stock for a Poor Man's Covered Call?
- Look for stable companies with a moderate bullish or neutral outlook, strong fundamentals, and highly liquid options. Avoid highly volatile or speculative stocks.
How to select the right LEAP option for a PMCC?
- Choose a deep in-the-money (ITM) call option (Delta 0.70+) with a long expiration date (1-2+ years out) to minimize time decay and best replicate stock movement.
How to determine the strike price for the short call in a PMCC?
- Select an out-of-the-money (OTM) strike price that gives the stock some room to move up, typically with a Delta between 0.20 and 0.40, to maximize the probability of expiring worthless.
How to calculate the maximum profit for a Poor Man's Covered Call?
- Maximum Profit = (Short Call Strike - Long LEAP Strike - Net Debit Paid for the LEAP + Premium Received from Short Call) * 100.
How to manage a Poor Man's Covered Call if the stock drops significantly?
- If the stock drops, your LEAP will lose value. You may consider rolling your short call to a lower strike (if you anticipate a rebound) to collect more premium, or close the entire position to cut losses if your outlook turns bearish.
How to handle assignment on the short call in a PMCC?
- If your short call is assigned, your long LEAP will typically be automatically exercised by Charles Schwab to cover the assignment. This effectively closes out the spread, and you'll realize a profit or loss based on the overall trade.
How to adjust a Poor Man's Covered Call if the stock rallies sharply?
- If the stock rallies significantly and your short call goes deep ITM, you can "roll up and out" – buy back the current short call and sell a new one at a higher strike and later expiration to capture more upside.
How to account for taxes on Poor Man's Covered Calls?
- Profits from PMCCs are generally treated as capital gains. Short-term gains (from short options held less than a year) are taxed at ordinary income rates, while long-term gains (from LEAPs held over a year) may qualify for lower long-term capital gains rates. Consult a tax professional.
How to close out a Poor Man's Covered Call on Charles Schwab?
- You can close the entire position by placing a multi-leg order to "Sell to Close" your long LEAP and "Buy to Close" your short call simultaneously. Use a limit order for better price control.
How to roll the long LEAP option in a PMCC?
- As your LEAP approaches expiration (e.g., 6-9 months left), you'll "roll" it by selling your existing LEAP and buying a new, longer-dated LEAP with a similar or deeper ITM strike to maintain your synthetic stock position.
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