In this post, I’m going to be sharing my strategy for playing this recent volatility. I’m using a couple different plays to hedge myself and leverage my gains.
Introduction
I started out buying 100 shares and was worried as I was averaging down my losses and Apple kept slipping. So I started selling covered calls against my first 100 shares of stock. Then I used that income to reduce the cost of a long term 1 year call option deep in the money at $90. Then Apple slipped some more putting my call substantially lower so I averaged down and bought two more long term calls and then sold two more covered calls against those to reduce the cost.
Now I’m long 100 shares AAPL and long 3 long term deep in the money calls while short 3 short term weekly calls. I will roll the short calls upwards as needed to avoid assignment (already rolled a $110 to $113.75) and if assigned, will give up the stock first, then the long options as needed.
The setup is shown in the picture below:
Explanation
I’m using a combination of essentially 3 diagonal spreads constructed with short out of the money calls and long term deep in the money LEAPS contracts with deltas around 0.8 and a year to expiration. In addition to this I buy 100 shares of AAPL to replace the collateral of 1 of the diagonals. This allows me to keep 1 long leg for a very reduced price and increases the likelihood of walking away with leveraged profits due to the capital efficiency of this stock replacement strategy.
If I’m assigned on all three, I am still left with a long call option which will have gained a lot by that point with all the upward movement and I will close that out and start again.
If my short calls expire out of the money and worthless, I get to keep the premium collected and use it to further offset my cost for my long calls/stock.
The last component of this strategy that gets closed is the final long leg. With a delta of 0.8 and a cost of around $2700, it provides about 80% of the exposure of the long 100 shares for about 25% of the cost which is why using it as a proxy for stock ownership is often called a stock replacement strategy and a poor man’s covered call when used as collateral against short option writing.
Poor Man’s Covered Calls
Similar to a traditional covered call, a Poor Man’s Covered Call (PMCC) is an options strategy used to profit from the premium made by selling/writing options. Unlike a traditional covered call though which use 100 shares of stock as collateral per contract written, PMCC’s utilize long option contracts as collateral to write short options against. This is a more capital efficient play than traditional covered calls due to the significant reduction in upfront capital required to enter the position.
In my setup, because I also include 100 shares of the underlying stock, I am free to retain a long call option to profit from instead of the shares themselves. Due to the lower cost of the option and higher leverage, the appreciation of the option should be greater than that of the underlying shares if the short legs were to be assigned. Giving up the shares instead of the long option in this case would yield a greater return.
You can learn more about Poor Man’s Covered Calls here from Tasty Trade:
Conclusion
With enough successful short option writes against the 2 other long options and the initial long 100 shares, that 25% cost of the final long leg will be reduced even further potentially becoming free to open in the end.
Gonna make a follow up post soon that further dives into the mechanics of these spreads and how to manage them. Feel free to reach out if there’s any questions!
