LEAPS Covered Call

No strategy seems to fire the imagination more than buying the LEAPS call (or other long-dated call) instead of the stock and then writing short-term calls against it. For that reason an entire chapter of this book is devoted to it further on. However, simply buying a long-term (L/T) call and writing the current call against it is not necessarily a good trade. What is ideal is an expensive current call and cheap L/T calls. We want the long calls to:

1)     be at least six months out in time and perhaps further, so that they are little affected by time decay,

2)     be ITM so that their delta is quite high, as least as L/T options go, and their vega is low, and

3)     have as little time value as possible, so that they are little affected by changes in implied volatility.

There are two primary variations of the LEAPS-Covered Call (LCC) strategy. One is to buy the long-dated call and write current calls against it for as long as possible, much like a portfolio stock. The low cost of the long-dated call compared to the stock itself results in a higher return. The same $2 of premium for the first call write is a much higher rate of return on a 13-month long-dated call costing $11 (22%) than on a $55 stock (3.8%). Some prefer stocks of at least medium-level historical volatility, to assure continuing good levels of premium return. Others prefer low-volatility stocks for stability and premium is of lesser importance.

The second variation is to treat the long-dated call as a surrogate for the stock, writing the call, then closing the position upon expiration of the short call, or closing it early – much like a buy-write.

Remember that selling short-term calls against a long-term call creates a calendar call spread, not a covered call. So long as there are no significant changes in stock price, the spread works fine.

The stock market is neither efficient nor random. It is not efficient because there are too many poorly-conceived opinions; it is not random because strong investor emotions can create trends.”

  • William J. O’Neil, CANSLIM Creator

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