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Long Call Break-Even Point (Poor Man's Covered Calls)
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Long Call Break-Even Point (Poor Man's Covered Calls)

  #1 (permalink)
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Long Call Break-Even Point (Poor Man's Covered Calls)

Hey everyone,

This is the first post I have originated on the website, but I have learned so much from everyone's discussions as a viewer. However, I wanted to ask today about the break-even point on long calls. The formula I have seen is: Strike Price - Current Underlying Price + Option Price= Required Increase. But does this formula really work? I ask skeptically because different call options have different deltas and varying expiration dates; would those two variables not come into effect when determining how high the underlying price must climb for the long call to break-even and begin to be profitable? If anyone could clear this up for me by providing a new formula, or some kind of calculator, I would greatly appreciate it.

It may also help to know in what strategy context my desire for this came about. The answer is poor man's covered calls; buying a long call (generally a LEAP) and selling a short call off of this position. I want to find the break-even point for my long calls in order to determine an attractive strike to sell my short calls at (a strike where, if assigned, my long call will be sold for roughly the same amount I paid for it). I know that in the case of assignment there may be slippage in the price of the long call, so any advice/experience on how much this slippage usually is would be helpful. Or just an amount to add on to the break-even point to account for potential slippage would be helpful too. In short, I want to make sure I am doing poor man's covered calls that if assigned will exercise my long call at a price as close to what I paid for it as possible.

Thank you all in advance for taking the time and assistance to help me in answering these questions, it is much appreciated!

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  #3 (permalink)
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The formula works, at expiration. Repeat: at expiration. Before expiration you can only estimate (softwares do this pretty accurately for the short term) the underlying price for breakeven point, there is no absolute as time is passing and volatility is changing.

As for this part "a strike where, if assigned, my long call will be sold for roughly the same amount I paid for it", if ASSIGNED, there is no way the price will be anywhere near. For example, A Jan ATM 208 call on the SPY costs 2.60, or $260 per contract. If assigned, you will need to pay $20800 because you are unleashing the "leverage" in the option.

I am not really getting the logic behind "In short, I want to make sure I am doing poor man's covered calls that if assigned will exercise my long call at a price as close to what I paid for it as possible." Why would you want price to be near what you paid for ? If you are assigned/exercised a long call, you want price to be as much ABOVE what you paid for as possible - buy low sell high ?

Spreads/slippage is dependent on what symbols and series you trade so can't answer that.

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  #4 (permalink)
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k20a View Post
The formula works, at expiration. Repeat: at expiration. Before expiration you can only estimate (softwares do this pretty accurately for the short term) the underlying price for breakeven point, there is no absolute as time is passing and volatility is changing.

As for this part "a strike where, if assigned, my long call will be sold for roughly the same amount I paid for it", if ASSIGNED, there is no way the price will be anywhere near. For example, A Jan ATM 208 call on the SPY costs 2.60, or $260 per contract. If assigned, you will need to pay $20800 because you are unleashing the "leverage" in the option.

I am not really getting the logic behind "In short, I want to make sure I am doing poor man's covered calls that if assigned will exercise my long call at a price as close to what I paid for it as possible." Why would you want price to be near what you paid for ? If you are assigned/exercised a long call, you want price to be as much ABOVE what you paid for as possible - buy low sell high ?

Spreads/slippage is dependent on what symbols and series you trade so can't answer that.

Thank you for the quick response concerning the break even point, that makes a lot of sense! And I realize how the language of my question was wrong, and therefore confusing. I was trying to find out, in the scenario of being ITM on this kind of trade, if the Long call could be sold instead of being exercised. Since it is a surrogate for the stock, I was hoping this could be done.

In other words, I sell a call on my LEAP, if it stays OTM, then the short strike expires worthless and I can sell another call for the next month. But in the case of it being ITM, my LEAP would be sold to cover it. Then I could just turn around, buy a new LEAP, and start over.

However, I am completely new to this strategy, so it looks like I just interpreted something wrong. Again, thank you for the helpful information, it is much appreciated.

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djcline94 View Post
I was trying to find out, in the scenario of being ITM on this kind of trade, if the Long call could be sold instead of being exercised. Since it is a surrogate for the stock, I was hoping this could be done.

In other words, I sell a call on my LEAP, if it stays OTM, then the short strike expires worthless and I can sell another call for the next month. But in the case of it being ITM, my LEAP would be sold to cover it. Then I could just turn around, buy a new LEAP, and start over.

Yes the long call can be sold/closed any time until expiration.

When playing this type of spread you should plan to never transact in stocks (as your aim was "poor man's covered call" meanning you probably do not have enough cash to cover a stock transaction), therefore if you short call is ITM, you should close it prior or on the day of expiry. Never let it actually physically expire in the money if you do not wish to own the short stock.

So there is no point in selling your LEAP to cover the short ITM call, and then immediately opening another LEAP. You are just doubling up on transactions on opening same position which means commissions/slippages. You just close/buy the short ITM call (prior to or a few minutes expiry) and still keep the LEAP call and then selling next periods calls. As long as you intend to keep the position anyway.

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k20a View Post
Yes the long call can be sold/closed any time until expiration.

When playing this type of spread you should plan to never transact in stocks (as your aim was "poor man's covered call" meanning you probably do not have enough cash to cover a stock transaction), therefore if you short call is ITM, you should close it prior or on the day of expiry. Never let it actually physically expire in the money if you do not wish to own the short stock.

So there is no point in selling your LEAP to cover the short ITM call, and then immediately opening another LEAP. You are just doubling up on transactions on opening same position which means commissions/slippages. You just close/buy the short ITM call (prior to or a few minutes expiry) and still keep the LEAP call and then selling next periods calls. As long as you intend to keep the position anyway.

Ah, that makes a lot more sense, thank you so much! So if my short call is ITM come close to expiration, I would want to just buy to close that position. My follow up question to this is: When buying to close that position, am I forfeiting the premium I brought in from when I first sold the call, and accepting whatever the loss is on the position for that month/period?

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djcline94 View Post
Ah, that makes a lot more sense, thank you so much! So if my short call is ITM come close to expiration, I would want to just buy to close that position. My follow up question to this is: When buying to close that position, am I forfeiting the premium I brought in from when I first sold the call, and accepting whatever the loss is on the position for that month/period?

Depends. You keep the premium, but you have to pay something to close it, if current market price (when you close it) > premium you received then you make a loss on that short call. If it is ITM by 50c, you probably pay about 52c on expiry day to close it. If you initially received 80c, you still make 28c on the short call. Though usually if it gets deeper ITM you will most likely lose as OTM premium are pretty low.

However you have to factor in the LEAP call too. Maybe you lose on the short call but the rise in the LEAP has risen more than the loss you took in the short call. Usually not though. If you sold far OTM and it gets ITM you most likely lost overall unless it is only slightly ITM.

You going to trade equities or futures ? What symbol are you planning on trading ?

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djcline94 View Post
Ah, that makes a lot more sense, thank you so much! So if my short call is ITM come close to expiration, I would want to just buy to close that position. My follow up question to this is: When buying to close that position, am I forfeiting the premium I brought in from when I first sold the call, and accepting whatever the loss is on the position for that month/period?

If your poor man's covered call short strike is in the money near expiration you should be over all at a profit (unless your having front month volatility issues). As you will have collected most of the extrinsic value as it deteriorated faster than your leap. And your leap should be moving more with the stock as it's Deltas go up. The 2 choices for me would be to either....close the entire position for a profit or roll the short strike out for additional credit or up and out for less credit or even money and look to keep collecting the Theta decay further reducing your cost basis on the Leap. I've done this many times to the point where I own the long calls outright and still have a couple of months on them.

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