Hello again traders, I know the market hasn’t been kind this past week, giving back most of the election gains. However, we can take heart because Jesus is still the best investment. With Jesus we’ll never have to worry about constant ups and downs. He loves us and will never leave us. I hope you’ll put your trust in him alone today and never in a place as fickle as the stock market.
Having said that, I feel today is an appropriate time to revisit one of my absolute favorite options strategies for income. The Poor Man’s Covered Combo options strategy takes advantage of any market environment. Additionally, the poor man’s covered combo was included in a recent post, “My Top 5 Options Strategies”.
Post Agenda
- Poor Man’s Covered Combo Overview
- Goal of the Poor Man’s Covered Combo
- Possible Performance of the Poor Man’s Covered Combo
- Keys to Success
Poor Man’s Covered Combo Overview
Before we go to far it’s important to understand the construction of this unique options strategy. Exactly as the name would imply this is a variation of the poor man’s covered call. For clarity, the poor man’s covered call is the purchase of a LEAPS option with a nearer term short option. The variation in this case is the addition of a LEAPS put with a nearer term short put.
In this way, no matter what the market is doing, income is earned on one side of the market. Even better, if the short options are sold just OTM a neutral market generates an even better income return. However, anyone considering such a strategy should carefully understand the risks. Large market moves or even large volatility swings may create losses to one of the LEAPS options, and thus total return.
That said, it’s also important to know that at it’s core the strategy isn’t designed for maximum total return. Rather, the poor man’s covered combo is meant to take a sum of capital and spin off maximum consistent income. The strategy would be considered a complete win if enough income is earned to replace the initial investment.
Goal of the Poor Man’s Covered Combo
Well, to state it simply, the goal is income. However, there is a process to successful implementation of the strategy. On the surface, for any seasoned options trader, the strategy is fairly straightforward. We would simply buy a LEAPS put and call, then begin selling shorter dated options against them. Though, for a newer trader, its probably not the greatest introductory strategy.
One, there is a high probability that total return could end up as a loss. For someone hoping to grow their account such a result would be pointless. Still, for those seeking consistent income the poor man’s covered combo should be on their radar. As opposed to the typical PMCC, the poor man’s covered combo generates income in any market. The challenge is making sure the LEAPS option has enough time remaining and thus not bleeding premium too quickly.
Ultimately, I think this strategy is best suited to an intermediate or advanced level options participant. Sure, the mechanics are easy enough for a beginner but the psychological strain from a large paper loss is never comfortable.
That said, the overarching goal is really three fold;
- Generate consistent and predictable income
- Exit the position before theta takes a meaningful toll on LEAPS
- Roll the shorts as necessitated by market movement or theta decay
Possible Performance of the Poor Man’s Covered Combo
With that out of the way we can now turn attention to what could be expected from this options strategy hybrid. To do that we’ll be using Thinkorswim’s OnDemand feature to recreate a hypothetical position throughout 2023. Any year would of course suffice, I just chose 2023 because my OnDemand was already there from a previous test.
Test Parameters
- Start – January 3, 2023
- End – August 18, 2023
- SPY ETF
- Commission cost – $.65 per contract
| Long Puts | Long Calls | Short Puts (Income) | Short Calls(Income) |
|---|---|---|---|
| ($3951) | ($3508) | $665 | $505 |
| ($451) | $624 | $157 | $16 |
| $345 | ($275) | $180 | ($222) |
| $181 | ($288) | $233 | $56 |
| ($454) | $602 | $174 | $198 |
| ($151) | $307 | $204 | $336 |
| ($436) | $637 | ($156) | $129 |
| ($275) | $648 | ($7) | $13 |
| ($478) | $1397 | $210 | ($445) |
| $173 | ($311) | $556 | ($236) |
| $2474 | $2375 | $320 | ($193) |
| $332 | ($591) | ||
| $69 | ($220) | ||
| $334 | ($257) | ||
| ($928) | $256 | ||
| ($81) | |||
| ($3023) | $2208 | $2343 | ($736) |
| Total Return | $724.40 |
| Total Commission Cost | $67.60 |
| Total Gross Return | $792 |
| Average Income per Month | $200 |
| Average Income per Day | $6.68 |
| LEAPS DTE at Entry | 535 days |
| Short Contracts DTE | 28 – 75 DTE |
Now, let’s take a look at the results. First, you’ll notice the total return was positive which is great. However, as previously mentioned, if total return was the goal we could have earned $992.18 over the same time period holding an equivalent dollar amount in shares. In fact, slightly less capital was used to achieve $992.18. Although, over that period the money would have been locked away without any use other than sitting idle.
By using the poor man’s covered combo options strategy I was able to invest just shy of $7500 and earn an income of approximately $200 per month. Honestly, the only reason I ended in August is because I was getting bored of back-testing the strategy for the bazillionth time. The income generation ability with this unique strategy is second to none, in my opinion. If you know what you’re doing. In the next section I’ll offer a few key criteria to the strategy.
Few Keys to Success
- Don’t purchase long option under 400 DTE, prefer 500 DTE or more.
- Doing this will allow for rolling up and down within that expiration for the entire year. Having to roll to further expirations has only increased the cost in my experience.
- Close or roll the final long option when only 100 – 150 DTE remains.
- Roll short contracts when price has tested one side or when lion’s share of premium has been extracted.
- Look to adjust the strategy once a week. More than that is overtrading in my opinion but it can be done effectively if desired.
- Strategy adjustments;
- Roll short call or put either in the same expiration or to the next expiration per above criteria. Seek a credit.
- Roll long call or put in the same expiration when large price moves occur.
- Keep an eye on theta from week to week. Aim for a theta of 5 – 10 per day per lot.
Final Thoughts
There it is, an income strategy for those of us that enjoy options trading. The poor man’s covered combo options strategy is my preferred approach to income generation when I have the time to focus on it. With this strategy there is a fair amount of work involved, at least compared to just buying and holding an asset. Therefore, if you are considering an income strategy but don’t have at least one day a week to focus on adjusting the position then I’d probably avoid this one entirely.
As mentioned, the strategy seeks to employ a relatively small amount of capital for the purpose of generating income. Income that can then be utilized elsewhere while the strategy is ongoing. For more detail surrounding the strategy I made a short video on Youtube some time ago that shows the strategy in action. I’ve made a few tweaks over time but the concept is the same. I hope you enjoy the strategy and look forward to hearing your thoughts below.
Until the next post.
God bless,
Jeff
