🔥 The 1% Strategy: How LEAPs Can Supercharge Your Covered Call Profits! 💰

Understanding Covered Calls

A covered call is a well-known options strategy used by investors to generate income through option premiums. It involves selling a call option while holding an equivalent amount of the underlying stock. This approach is beneficial for those who have a neutral to slightly bullish outlook and want to enhance returns while mitigating minor price declines.

However, the strategy limits upside potential. If the stock price surges above the strike price, the stockholder must sell at the agreed price, capping their profits. Additionally, buying 100 shares of stock to execute a traditional covered call requires substantial capital, increasing downside risk if the stock price falls.

Introducing LEAPs in Covered Calls

A variation of the covered call strategy uses Long-Term Equity Anticipation Securities (LEAPs) instead of purchasing shares outright. LEAPs are long-dated call options (expiring beyond a year) that provide control over the stock at a fraction of the cost. This approach is known as the "leveraged covered call" or "poor man’s covered call."

Why Use LEAPs?

• Lower Capital Outlay: Buying a deep in-the-money (ITM) LEAP requires significantly less capital than purchasing 100 shares.

• High Intrinsic Value: Deep ITM LEAPs closely track the stock price, mimicking actual ownership.

• Risk Reduction: The maximum loss is capped at the price paid for the LEAP, unlike stock ownership, where losses can be greater.

• Income Potential: Selling short-term call options against a LEAP can generate regular premiums, just like a traditional covered call.

How the LEAP Covered Call Works

Instead of buying 100 shares, an investor purchases a deep ITM LEAP call with a delta close to 1.00. This means the LEAP moves nearly one-for-one with the stock. The next step is to sell short-term call options against this LEAP position, just like in a traditional covered call.

If the short call is exercised (i.e., the stock price surpasses the short call’s strike price), the LEAP holder can exercise the LEAP to buy 100 shares at the lower strike price and deliver them at the short call’s higher price, fulfilling the obligation without additional stock purchases.

Example of a LEAP Covered Call

1. Buy a LEAP: Purchase a deep ITM LEAP for XYZ stock (trading at $50) with a strike price of $30 for $21 per share ($2,100 total).

2. Sell a Short-Term Call: Sell a one-month call option at a strike price of $55 for a $1.50 premium ($150 total).

3. Potential Outcomes:

   • If the stock remains below $55, the option expires worthless, and you keep the premium.

   • If the stock rises above $55, you exercise the LEAP, buy shares at $30, and sell them at $55, realising a profit ($25 per share)

Risks and Considerations

While this strategy reduces capital requirements, it comes with risks:

• LEAPs Expire: Unlike stocks, LEAPs lose all value if the stock is below the strike price at expiration.

• Liquidity Issues: LEAPs often have wider bid-ask spreads and less trading volume.

• No Dividend Earnings: LEAP holders do not receive dividends, unlike stockholders.

• Market Volatility: If the stock price drops significantly, the LEAP's value may decline faster than expected.

Conclusion

Using LEAPs in covered calls is an effective way to generate income while reducing initial capital investment. This strategy mimics stock ownership but requires less upfront cash, making it an attractive alternative for long-term investors. However, it is essential to understand the risks and manage positions carefully to avoid significant losses. With the right execution, leveraged covered calls can be a powerful tool in an investor’s options strategy arsenal.