Options Trading: POOR MAN'S COVERED CALL & COVERED PUT STRATEGIES

1. Introduction: Hey there and welcome to my class on the impairments covered call and poor man's covered put strategies. Now these strategies are very similar to the regular cover call and cover PUT. And perhaps you've heard those before, but if not, don't worry, this class covers everything, but the regular cover colon covered put our great for combining both stock and options together to give you a much higher probability of profit than just buying stock or just buying options by themselves. But the main issue with those strategies is that can be very capital intensive. And that's where the poor man's variant of these strategies comes into play, right? So the poor man's cover call and poor man's covered put are much more capital efficient. And so like I said it in this class, you're going to learn about everything. I'm going to start off by giving you a brief overview of the irregular covered call uncovered put for context. And then you will see how to translate that into the much more capital, efficient, poor man's variant of those strategies. And before I continue here, I just want to say that by no means do you actually have to be poor to use these strategies. It is simply a funny name that indicates just how capital efficient these strategies really are. Now this is the first course of mine you've come across. My name is Scott Reese. I currently work as both a software engineer and the financial services industry, and I'm also an entirely self-taught and self-directed trader and invested in the stock market. And that's my goal here with this channel that I've created on Skillshare to help people like you also become confident and self-directed traders and investors also. And to give you some more context into my background, I studied both computer science and economics at UC Berkeley. And so in my classes you will see a lot of the same information I was taught back in college. In addition to everything else I've learned from my own independent research and experienced trading in the real markets. And finally, before getting started here, I just went to announce that you can also find me on YouTube. I recently started my own channel where I'll be continuing to push out content related to trading, investing, and personal finance. And you can simply navigate to my profile page on Skillshare. And there you will find a link that will direct you right on over to my channel. So be sure to check that out and subscribe so you don't miss out on any of my content. And so with that being said, let's jump on over to my computer now and we'll get things started. 2. CC & CP Overview: Okay, welcome to the first video of this course on the poor man's covered call and poor man's covered put strategies. And know you certainly don't have to be poor to use these strategies. It is simply the name of the strategy. And that's simply because the poor man's cover call and cover PUT is the cheaper alternative to the regular covered call and cover put. Because as you'll see here in a second, the irregular covered call uncover put, can require a lot of capital for stocks with high prices. And so the poor man's variant on these strategies is a great choice if you have either a smaller account or if you simply want to use less capital for some stocks than what would be required for the regular covered call uncover put. So now coming over to the next slide, I wanted to give you a brief overview of the regular covered call and cover put strategies. Because understanding how these work is going to be crucial to then understand how the poor man's version of these strategies actually works as well. Now for some of you, this may be a review if you already have some understanding of these strategies. And for some, this might be brand new material. But either way, it's very important to pay attention in this video because this will give you a very solid foundation for understanding the rest of the material in this course. And quickly before we get started here, I just wanted to say that this video is going to condense a lot of information. And so even if you have very little to no understanding of the regular covered call or cover put strategies. I think this video will totally get you up to speed on them. But in the case, if you want to see more in-depth explanations or more examples of these strategies. I do also have a totally separate course on Skillshare dedicated just for the regular cover call uncover put strategies. So I just want to make you aware of that in case you need more information after watching this video. So on a very high level, both of these strategies, the regular cover call uncovered put, involve two main components, shares of stock and a short options. And by short options, I mean, you are selling options. You're either selling call options or you're selling put options. And so the reason why stock is involved with the strategies is because the stock is used to cover the obligations of those short options. And we'll talk about those obligations next here. So focusing first on the cover call, what does it mean to actually sell a call option? What is your obligation for doing this? Well, it simply means you are obligated to sell 100 shares of the stock at the strike price, come the expiration date, or if the buyer of the contract exercises that option early. And another way to look at this is from the buyer's perspective of the contract, that person you're selling the call to. Well, buying a call option gives the buyer the right to purchase 100 shares of stock at the strike price. But who are they going to be buying those shares of stock from? Well, they're going to buy those shares from the seller of the contract, the person who sold the call option. And so that's why if the buyer of the contract does want to purchase those shares, you as the seller, are obligated, you must sell those 100 shares of stock at the strike price. And so if you do want to sell a call option, the way you cover this obligation is beforehand. Before you sell the call option, you just buy the stock. You buy those 100 shares yourself, right? Because once you have those 100 shares in your portfolio, now you can sell them at anytime for any price. And so then once you do sell that call option, and if down the road, either come the expiration date or a bit beforehand, if the buyer of that contract wants to purchase those 100 shares, well, you already have them in your portfolio. So now you can just sell them. And actually in this scenario, you would be able to do so for a very nice profit. And I will also show you examples of all of this in my trading platform in a second, once I cover the high level information here. So now what about the cover put will in this case, what does it mean to sell a put option? And what you'll find here is that everything with a cover PUT is simply the inverse, the opposite of the cover call. So if for selling a call option, you are obligated to sell 100 shares of stock at the strike price. Then for selling a put option, you are obligated to buy 100 shares of stock at the strike price. It's just the opposite. And once again, thinking about the full picture here from the buyer's perspective of this put option. Buying a put option gives that person the right to sell 100 shares of stock at the strike price. And so if the buyer doesn't want to use there put option to sell those shares, who would they go into be selling the shares to? That person who's sold them the contract. So this is why once again, when you sell a put option, you are obligated. You must purchase those 100 shares of stock from the option buyer, the person you sold the contract to. And so this means to cover that obligation before you sell that put option, you short 100 shares of the stock. Again, just the opposite of buying the stock beforehand when selling a call option. And in case you're not aware of what's shorting a stock means. It is simply the way you make money when stock prices go down as opposed to going up. If you think the stock price is going to increase, you buy the stock. And then if you think the stock price will go down, you short the stock. And when you do this, you are essentially borrowing shares of stock from your broker. You then immediately sell those shares in the market for the current market price. And then at some point down the road, you buy the shares back and return them to your broker. And hopefully you bought those shares back at a lower price, right? Because if you sell initially at a high price and you buy them back at a lower price, you'll make the difference as profit. And so ultimately here, if getting out of a shortstop position means you have to buy the shares back at some point. And if selling a put option means you also have to buy shares of stock, Then hopefully you see how short stock is used to cover the obligations on a put option. But if not, don't worry, because now I'm going to show you a few examples here. So what I have pulled up is a one-year price action chart of Twitter. And so first, let's look at an example of a covered call. So let's come over to the trade tab now and take a look at the option chain on Twitter. And we'll go into the June exploration cycle. These options expire in 37 days from today on June 18th. And on the left-hand side here, these are all the call options. On the right-hand side, these are all the put options. And then down the middle, these are all the different strike prices you can choose. And so like I showed you on the PowerPoint slide, the first step of a covered call strategy is first buying 100 shares of the stock. So I can just go up here and click on the price of Twitter, which right now is at $52 in 88 cents. Click on that. Go to buy. And then down here by default at brings up in order to purchase 100 shares of stock. And I can also adjust my limit price here if I want to buy these shares at a specific price. So once I've done that, I will just confirm and send and then buy the shares. And once that is done, the final step would be to figure out which one is call options I want to sell. And perhaps for me, maybe I want to sell this option right here. This would be the 55 strike call option. And looking at the bid and ask prices and going right in-between, the fair price for this option would be right around 204 or $205. And so what I can do is click on the bid price here. And that brings up a sell order for this contract. And I would set my limit price for maybe $204. That's what I want to sell this contract for. Hit Confirm and send, send the order. And then boom, I'm now in my cover call strategy. And so let's think about what this all means here for a second. If you recall from the PowerPoint, this call option selling this call option specifically means come the expiration date, June 18th, I would be obligated to sell 100 shares of Twitter stock. The strike price at 55 bucks per share if the buyer of this contract wanted to buy those shares for me. And the only way the buyer of this contract would actually want to buy those shares for me, would be if by June 18th, the price of Twitter was above the strike price, above 55 bucks per share. So for the sake of example, let's say by June 18th, Twitter was at 58 bucks per share. And so now like I just explained in this scenario, the buyer of this contract is going to use the call option to purchase those 100 shares at the strike praise at only 55 bucks per share. And that's totally fine for me as the seller of the call option. Because before I even sold this option, I already bought those 100 shares at a lower price at $52.88. So if I bring up the calculator here to make this more clear, I'll move this over here. If I'm obligated to sell my shares at a price of 55 bucks per share. And if I initially bought those shares at $52.08, that means I will profit $2.12 per share. Multiplying that by the 100 shares I bought, That's a profit of $212. And on top of this, don't forget, I also sold his contract for $204 and this amount of money I will always get to keep as the options seller. So now I tack onto this another $204. So my total profit on this trade in this scenario is $416. That's great. So the regular cover call strategy is a bullish strategy. You want the stock to go up. Now of course, if Twitter goes to the moon, if it goes from 52 bucks per share to a 100, unfortunately, you will not get to participate in those additional gains, right? Because no matter how high Twitter goes, I will always have to sell those shares at only 55 bucks per share. That's my obligation. But this still is the best-case scenario. You will make the most amount of money on this position if the stock actually blows through your call strike. And finally, because I took in this extra 204 bucks when selling this call option, I can always use this money to offset any losses if the stock price actually does decrease or just goes nowhere. Right now let's say in this example, let's say by June 18th, Twitter actually falls in price by maybe $1. It goes from 50 to 88, down to 5188 by the expiration day. So now clearing the screen here, if the price falls down to 5188, and I initially bought the shares at 50 to 88. That's obviously a loss of $1 per share times the 100 shares. That's a loss of $100, just on the stock position. But like I said, you will always get to keep the premium you sold a call option for. And in this scenario, if Twitter actually falls in price, this call option just expires worthless. You will not have to honor any obligation on this contract, but you'll still keep the premium here. So ultimately, if I add to this the $204 I keep from the call option, that means I still make a profit on this overall position of $104. So the regular cover cost strategy can make money if the stock price goes up, that's the best-case scenario. Or if it goes sideways, goes nowhere, or even when the stock price drops by a little bit. And so this increase in your probability of profit, this increase in the number of ways you can make a profit is your compensation for not being able to participate in the additional gains if Twitter were to go well above my call, strike here. I may have a capped maximum profit on this cover call here. But at least I can still make money even if the stock price does not increase. And that is not something that can happen if you would just bought the stock into nothing else. When you just buy shares of stock, the price must increase for you to make a profit. There's no other scenario where you can make a profit. Now what about the covered put strategy? Let's reset the screen here in a very similar fashion to the cover call. The cover PUT is just the opposite. So it's actually a bearish strategy. The best-case scenario is for the stock price to decrease, go down. And so before I sell a put option over here, the first thing I'm going to do, the first step is to short 100 shares of the stock. And it's very easy to do this. So once again, I'll come up to the stock price, click on that. And instead of clicking by, I'll just go to cell. And this brings up an order to by default short 100 shares of Twitter stock. And same thing, I'll set my limit price. Maybe I'll come down to 5188 just to keep things consistent and then confirm and send. And so just keep in mind here that what this is going to do is I'm going to borrow the shares for my broker and then immediately sell them in the market at this price. And once I've done that, the final step is to sell a put option. So perhaps I want to sell this one here. This is the 50 strike put option, which is trading for about 171 to $172. So I can just click on the bid price here. And that brings up a sell order for this contract. And then I'll set the limit price to 171. Confirm and send. And then boom, I'm now in my cupboard put position. Now let's walk through a few examples here. So like I said, this is a barrier strategy. So in our first scenario here, Let's say the stock price falls from 50 to 88 down to 45 bucks per share by the expiration date. That is now just like with the cover call option. It does not matter how far Twitter actually blows through my put strike here, because I'm always obligated to buy, in this case, to buy 100 shares of stock at the strike price at 50 bucks per share. So even though in this scenario, even though Twitter's at 45 bucks per share by the expiration date too bad. I can only make profits up to Twitter going down to 50 bucks per share. But I'll still make a very nice profit on this. So once again, let's bring up the calculator here, and I'll move this over here. So if I initially shorted 100 shares of stock at $52.88 and keeping in mind to close out of a shortstop position, I have to buy those shares back. Well, that's what this put option will allow me to do. So now come June 18th, if I have to buy the shares back at 50 bucks per share. So I'll subtract 50 bucks per share. That means I make a profit of $2.08 per share times the 100 shares. That's an overall profit. Two $188. Very nice. And then don't forget, I also can tack on the $171 I sold the put option for initially. So I add 171 and my total profit at the end of the day is $459. And then finally here, just like with the covered call position, where I could still make money even if the stock price went down. Well, for the cover position here, I can still make money even if the stock price increases. Which might sound a bit odd. But remember, when you short a stock, you want the stock price to go lower. And the way you lose money on a shortstop position is that the stock price actually increases. Everything is the opposite. So now let's say by June 18th, Twitter actually increases in price by $1 to $53 in 88 cents essentially. Well, if we first look at the stock position on this strategy, if I initially shorted 100 shares at a price of 52 bucks and 88 cents, and then the stock price increases to $53.88. That's going to be a loss of $1 per share times the 100 shares. That's an overall loss on the stock at least of $100. Because I sold this put option for $171 and I always get to keep this amount of money. I can just add on that 171. And I can still at the end of the day walk away with a profit of $71. And this is what I love about these covers strategies. You can still make money even when you are completely wrong on the trade. With a cover put, I want the stock to go lower. Perhaps my analysis said the stock would go lower. But even in the case where I am wrong, although to a limited extent, even when I'm wrong, I can still walk away with some profit. And that's a really powerful thing. But the major caveat with these kinds of strategies is you do need to have the capital to either buy or short at least 100 shares of the stock. And that's because for every contract you sell either a call or put in order to fully cover the obligations of the contract. You need to, as I said, either buy or short 100 shares of stock. Option contracts are tied in increments of 100 shares of stock. So as a quick side note, if for this cover put strategy, if I wanted to sell two of these contracts, not just one, well that means beforehand I would have to short 200 shares of stock, not just 100. And as I'm sure you can imagine, that amount of capital required can certainly add up, especially if the stock price is very expensive. And even for a moderately priced stock like Twitter, at only 52 bucks per share, well, having to buy or short 100 shares at this dog is going to cost over $5,200. Now of course, you can also use margin to do this, which means you'll only have to put up half the amount of capital to do so. And the other half you'll actually borrow from your broker. But even on margin, half of 5000, almost $300 is still 2650 bucks and that is required just for selling one contract. So even though these cover call and cover put strategies are great, they're very effective and they give you a very high probability of profit. You do need to have some amount of adequate capital to be able to put on these positions. And so if you either do not have the capital or simply don't want to have to put up that amount of capital. That's where the poor man's variant of the strategies comes into play. Because the poor man's covered call and poor man's covered put are going to require significantly less capital for a very, very similar kind of position. And that's what we're going to start discussing in the next video. So thanks for watching, and I'll see you in the next one. 3. Delta, IV, and EV: All right, Thanks for joining me here again in the next video of this course. And so now in this video, I'll be discussing first off how we can convert the regular covered call and covered put that you saw in the previous video into options. And that's because the poor man's covered call impairments covered put only involve options. And so then on top of that in this video, I'll be teaching about a few concepts relevant for options because you will need to understand them to effectively use the poor man's covered call uncover put. And so as you saw in the previous video, the capital intensive portion of the regular covered call uncover put is having to purchase 100 shares of stock or shorting 100 shares of stock, right? That can require a lot of capital, especially for moderately to very expensive stops. So for the poor man's variant of the strategies, instead of buying or shorting a 100 shares, you're actually just going to buy options. These options are going to act as replacements for actually buying or shorting stock. And so specifically, when you buy a call option that is going to simulate buying shares of stock. And then conversely, when you buy a put option that is going to simulate shorting shares of stock. Now this begs the question though, of which call option or which put option should I be buying? And the answer to that is, these options you will purchase are going to be long-term. The money contracts. That's what ITM stands for. And I'll be showing you examples of all of this in this video as well. And the reason why you're going to buy long-term in the money contracts is because these options in particular do behave a lot like stock. And also there's still going to be a lot cheaper than actually buying or shorting shares of the stock. Now coming to the next slide, there are a few concepts you must understand about options in general. And the three most important things for this course are going to be delta, intrinsic value, That's what I-V stands for, and extrinsic value, or EV for short. So let's take a look at delta first. And delta is essentially a mathematical concept which is derived from the Black-Scholes option pricing model. And as I'm sure you can guess from the name here, the Black-Scholes option pricing model is a theoretical mathematical equation that you can use to price a call option or a put option. But that's a topic outside the scope of this course. Just understand that delta comes from this pricing model. Now what does it do? What does delta mean? Well, specifically, delta will tell you how much the price of an option will change for a $1 move in the stock price. So every option has a corresponding Delta to it. And when the corresponding stock price either moves up or down by $1, you use delta to figure out to at least get an estimate of how much the price of that option contract will change as a result. And so there are a few other ways to interpret delta. The most important of which for this course is delta, also equates to the number of shares that you are either long or short for that contract. So for example, if you bought a long-term in the money call option with a delta, AT that call option would simulate you having purchased 80 shares of stock. But again, I'll show you examples of all of this here in my trading platform in a moment. But delta is essentially how you translate shares of stock into the options world. Now what about intrinsic value? Well, this is one of the two main components of the price or the value of an option contract. And you might guess that the other component is the extrinsic value. And we'll get to that here in a second. So intrinsic value is the value of an option if it were to expire today. So if an option expired in the money, it will have some worth at that time, and that would be the intrinsic value. But if the option expired out of the money and was therefore useless, it would have no value, no intrinsic value. And then finally, the extrinsic value. The other component of option pricing is the additional time value of an option on top of its intrinsic value, right? Because not all options expire today. Of course, most options expire at some point in the future. And there is value in being able to hold onto that contract for that period of time. And finally, as I mentioned earlier, the price of an option is simply the sum of the intrinsic value and the extrinsic value. So now that I've covered the concepts here, Let's look at a few examples. So once again, we'll take a look at Twitter stock, and we'll go over to the trade tab and look at the options on Twitter. Select you saw on the first slide, instead of buying or shorting shares of stock to do the poor man's covered, color cover put. Instead we're going to buy long-term in the money option contracts. So given that Today's date is May 17th, 2021, Let's take a look at the December expiration cycle. These options expire in 214 days from today are basically read around seven months. And so let's focus on this 45 strike call option. This would be the main example to demonstrate how a Delta works, as well as intrinsic and extrinsic value. Now up here, you might notice we have a Delta column which shows you for every single one of these color options, the corresponding delta value, right? Like I said, every option has its own delta. And for this 45 straight call option, the delta is 73. Now I know it's coded here as 0.73. But all these numbers are quoted on a per share basis. Which means that given these option contracts are tied to 100 shares of stock, you just divide everything by 100 and that gives you the delta or the theta, the Vega, et cetera. These are other metrics, as well as the prices of these options on a per share basis. So for example, with the price of this option, the bid price is $11.10, the asking price is $11.95. So going right in-between, the fair price for this option would be right around $11 and 50 cents on a per share basis, or in total, if you multiply that by 100, the full price for this option is one hundred, one hundred and fifty dollars. And same thing with a delta. You can also multiply this by 100 to get 73. So that is a pretty minor and irrelevant detail, but I still wanted to make you aware of that. So you aren't confused as to why these numbers are quoted as decimals. And so if you recall from the slide that delta will tell you how much the price of this option will change for a $1 move in the price of, in this case, Twitter stock. So as an example, right now, Twitter is at $52.60. And so if the price of Twitter or to either increase or decrease by $1 from this point, you would expect the price of this option to move by about $73 or $0.73 on a per share basis. And because this is a call option and call options increase in price when the corresponding stock price also increases. That means if Twitter were to move from 50 to 60, 250, 360, the price of this call would increase by $73. And then conversely, if Twitter fill down to 50, 160, the price of this call option would fall by about $73. Now tying in that second interpretation of delta though, which is that delta also represents the number of shares that you are synthetically either long or short when you hold this contract. So in this case, if I were to buy this 45 strike call option, it would simulate very closely buying 73 shares of Twitter stock, right? Because if you think about it, if I bought 73 shares of Twitter stock at the current price of 50 to 60, and then the stock price increased by $1 to 50, 360. How much money would I profit on that position? Well, I would profit $1 per share times the 73 shares I bought. That's a profit of $73. And that would be the same exact profit as if I just bought this call option instead, right? Again, if I bought this call and then Twitter increased in price by $1, the price of this option is going to increase by $73. So that's why buying this call option or just purchasing 73 shares of stock. Those two things are equivalent positions. And the same exact concept applies to the put options as well. So if you focus on the 65 strike put option here with a 67 delta, buying this contract would simulate shorting 67 shares of stock. Now what about intrinsic value and extrinsic value? Well, let's focus back on our 45 strike call option. And if you recall from the PowerPoint, intrinsic value is simply the value of an option if it were to expire today. So let's pretend for a moment that we fast forward time 214 days all the way to December 17th and that today is expiration day. And so what would be the value of the call option here at expiration? And the answer to that is simply how far in the money this option is. So given that the strike of this call option is 45 and the current stock price is 50 to 60. That means this call option is a full $7.60 in the money, right? You just take 50 to 60 and subtract from it the strike price. So $7.60 is how far in the money this collection is. And that's also the intrinsic value of the contract because that's exactly how much profit I would make on this call option, at least in regards to trading the stock on the expiration day. Overall, this would still not be a profitable outcome because I will be paying more for the call option then that would be profiting with trade in the stock. And that has to do with the extrinsic value, which I'll talk about here in a second. But for example, and I'll pull up the calculator here to make this more clear. I'll move this down here. If buying a call option gives me as the buyer the right to purchase 100 shares of stock at the strike price of 45. In this scenario, I would definitely exercise this option to do just that. Because once I take ownership of those shares, I could then immediately turn around and sell them at the market price at 50 to 60. So bringing this full circle now, I exercise my call option to buy 100 shares of stock at a price of $45 per share. That will cost money. And then I can turn around and sell those shares in the market at a price of 50 to 60, which means I will profit $7.60 per share. And then of course, times the 100 shares, that's an overall profit of $760. And like I said, this is the intrinsic value of this call option, at least for the moment, right? Depending on how far this option is in the money that will dictate the intrinsic value of the contract. And obviously, Twitter can move around quite a bit every single day. So if tomorrow, if Twitter increases in price, that will increase the intrinsic value of this contract. And then conversely, twitter cells off that will decrease the intrinsic value of this contract. But the interesting thing though, is that the price of this option today, still a ways away from the actual expiration date is far above its intrinsic value, right? This call option only has an intrinsic value of $760, but the price for the contract is one hundred, one hundred and fifty dollars. And that additional value is the extrinsic value of the contract. So if I clear the screen here and take one hundred ten hundred one hundred and fifty minus 760. That leaves $390 of extrinsic value built in to the price of this contract. So this is basically the value of the remaining 214 days until the actual expiration date. This is what option buyers pay up for. This is what they pay beyond the actual worth of the contract because there is value in time. Who knows what can happen in 214 days, Twitter could double in price, and in which case if I bought this collection today and Twitter did double in price by the expiration date. I would make a lot of money on this contract way way more than the additional 390 bucks I have to pay to buy the contract, right? This would basically be an insignificant little fee compared to the profits I could make with this call option. Now of course, there is no guarantee that this option will ever pay off. Perhaps by December 17th, Twitter may actually decrease in price, but the fact of the matter is, is people will still pay additional money to buy options because of that possibility of a great payoff, there is always value in time. And again, the same concept applies to put options as well. To figure out the intrinsic value of the 65 strike put option here, we just need to figure out how far in the money it is at the moment. So if I clear the screen, we just take 65 minus the current stock price of 50 to 60. And that gives you $12.40. And this would be on a per-share basis. So multiplying by 100, the intrinsic value of this contract is one hundred, two hundred and forty dollars. But just like with the color option here, the current price for this put option is significantly greater than its intrinsic value, right? This put option is trading for about one hundred and five hundred and thirty bucks or so, almost $300 higher than its intrinsic value. And again, that's just because there is value in those 214 days remaining until the expiration day. Now those examples were for in the money options, right? What about out of the money options? Well, if you focus on the 60 strike call option, which is currently out of the money, this option is still trading for well over $400, even though if expiration was today, this option would be absolutely useless. So this collection currently has 0 intrinsic value. And so that means the price of this option right now is 100% extrinsic value, right? The fair price for this collection is about 450 bucks or so. And that is the extrinsic value of the contract. So this definitely highlights the fact that there is value in time. Because if I bought this option, I'm essentially buying a useless product if the expiration date was actually today. But it's not. Expiration is 214 days from today. So because there's plenty of time between now and then, for Twitter to increase in price well above 60 bucks per share, I am willing to de, to pay over $400 for this contract. And so there you go. That's delta intrinsic value and extrinsic value in a nutshell. And the importance of these concepts will become a lot more clear in the following two videos. When we start learning about the poor man's covered call and poor man's covered put. So thanks for watching and I'll see you in the next one. 4. The Poor Man's Covered Call: Okay, welcome back. And so now in this video here, we'll be taking a deep dive into the poor man's covered call strategy. So once again, we'll take a look at Twitter stock here. Let's go into the trade tab. And so as you recall that we were going to substitute buying stock as part of the poor man's cover cost strategy is we're just going to buy a long-term in the money call option. So we'll take a look at the December expiration cycle again. And as of today, this cycle expires in 205 days from today. And in this video, we'll focus on this 50 strike call option here with a 73 delta. Now there is no magic number in terms of which delta you should choose for the option you're buying. But I would recommend going at least above 70. And that's because these options in here are still going to behave a lot like stock, but they're also going to still be pretty cheap compared to actually buying the stock itself. So in the case of this 50 strike call option, it's currently trading for about 1240 bucks or so, which is definitely a lot cheaper than buying 73 shares of Twitter, which right now is trading for just above 58 bucks per share. And so once you have decided which exploration cycle and which option you want to buy, the next step is to, of course, by the contract and also real quick in terms of the expiration cycle, again, there is no magic number, but I would say my recommendation would be to go at least three or four months out in time. This December expiration cycle is currently about seven months out from today. But again, I would say at minimum to go at least three to four months out. The reason being is options in further dated exploration cycles will have a lot less price volatility. And also, of course, this gives you a lot more time to be correct in your directional assumption. So at this point, I can just click on the asking price to bring up the byte order down here, I can set my limit price and then confirm and send, send the order and boom, I'm now in the trade. At least the first part of the poor man's cover call strategy. The second part now of course, is to sell and out of the money call option with a shorter term expiration date. So perhaps now I can go into the June exploration cycle. These options expire in only 23 days from today. And maybe I want to sell now the 60 strike call option for about 150 bucks in credit. And I certainly could go a bit further away to give the stock more room to run, because right now the stock is at 58 bucks per share, only two books away from my call strike. But of course, if I were to do that, I would have to give up a lot in credit, right? For example, if I instead sold the 65 strike call option, I could only sell this option for about 50 bucks. But the potential reward, if Twitter does bounce all the way through 65 bucks by the June expiration date than the profits could be much bigger. So it's going to be up to you to kinda figure out what the proper balance is for you between how much credit you went to collect and what the best-case scenario max payout will be. But my recommendation would be to sell an option with about 20 to 30 days left to go into the expiration date, and also somewhere around the 30 Delta. So in the case of this 60 strike call option, this option has a 39 delta, which is a bit high, but I personally like to collect a decent amount of credit for the options I'm selling. So at this point, I would just click the bid price to bring up the sell order down here against at the limit price, confirming, send, send the order and then boom, I'm now officially in my poor man's covered call position. So now let's talk about a few things, specifically involving delta and intrinsic and extrinsic value here. And so scroll back down to the option. We're buying this longer-term option with a 72 delta and actually now just moved to 73. So this is the first thing I want to discuss, and that is the delta of the contract that you're both buying and selling will change. Deltas are not static. And so what this means is buying this option, at least initially is equivalent to buying 73 shares of Twitter. But as Twitter increases in price, which is what you want to happen, the Delta on this contract is going to increase, right? You can see for these color options that are even further in the money, they all have higher deltas and this one. And so this is one of the reasons why the poor man's covered call requires significantly less capital than the regular cover call. Because regardless of all the deltas here, all these contracts are still tied to 100 shares at the end of the day, right? When you buy a call option, for example, this gives you the right to purchase 100 shares of the underlying stock at the strike price. But at least for the time being as of right now, at least this contract is not going to behave as though it was tied to those 100 shares. It's only going to behave as though it was tied 273 shares. But once the delta reaches 100, that's the highest A-delta can go to. At that point, then the contract will behave like the full 100 shares of stock. So bind this contract now is equivalent to buying only 73 shares of Twitter, but potentially by the expiration date, you'll have the advantage. Trading 100 shares of stock, not just 73. Now the second thing I want to discuss here has to do with the extrinsic value of this contract. Because now that we're dealing with options which have expiration dates and extrinsic value and other things. The poor man's cover call is obviously very similar to the regular covered call, but there are a few additional things you need to keep in mind. So to help make the math a bit easy here, let's just say that this call option is trading for exactly $1200. It would actually right now be worth about 1210, but just running down, call it an even 1200. And same thing with the current stock price just running down. Call it 58 bucks per share. Exactly. So now if I get out the calculator here, I'll move this down here. So if the stock price is currently at 58 bucks per share and the strike price of this call option is at 50. That means this collection is a full $8 in the money. And that translates to in intrinsic value of $800. So now to figure out the extrinsic value, we simply subtract 800 from the current price. So we take 1200 minus 800, and that gives you 400 bucks in extrinsic value. So why is this important for the poor man's covered call? Well, it's important because if you have to exercise this collection early, which I'll explain in a minute here. If you have to exercise your long call option early because you got assigned your shorter-term call option, you are going to forfeit the extrinsic value remaining in that contract. So as a quick example here, let's say I exercise this collection today, right now. So let's clear the screen here. And if I exercise my option here, which gives me the right to purchase 100 shares of stock at a price of 50 bucks per share, that's going to cost $5 thousand, right? And then once I have those shares, I can immediately sell them at the current market price. So that means selling 100 shares at a price of 58 bucks per share brings in 5800 bucks, then adding them together, that means I make a profit from trading the stock of $800. But keeping in mind, if I spent $1200 from buying the contract, I still lose 400 bucks overall. That's the extrinsic value remaining in the contract, right? Because once you exercise your call option, it's gone forever. So again, if you have to exercise your longer-term option early, you will be forfeiting the remaining extrinsic value in the contract. Now why would I potentially have to exercise my option early? And as I mentioned, the reason being would be if I got assigned on my shorter term call option. Right. If by the June expiration date, Twitter was above my short call strike of, let's say 60 bucks per share. That was the example I chose. Then I will get assigned on this call option. And my obligation here is to sell 100 shares of Twitter at a price of 60 bucks per share. And I must honor that obligation. And those 100 shares have to come from my longer-term option. So basically what I'm getting at here is if the situation does play out, which most likely will at some point, you want to make sure the profits you will make in this scenario, because this is actually a good scenario, you simply want to make sure that profits you will make, will more than compensate the extrinsic value you will lose on your longer-term option, right? So again, if I were to exercise this collection today, I would lose $400. But if I make more than 400 from the shorter term contract, then that's fine. I still walk away with a net profit. So now let's fast forward 23 days into the future, all the way to the June expiration date. And let's say for the sake of example, Twitter is at 65 bucks per share. So it's well above my shorter term called strike here. As I explained, I will get assigned on this contract and I will have to sell 100 shares of Twitter at a price of 60 bucks per share. So once again, let's bring up the calculator and let me move this up a little bit here. There we go. So at this point I will have to exercise my longer-term call option to purchase 100 shares at a price of 50 bucks per share. So step one is purchase those shares for 50 bucks per share. And then now to honor my agreement on this short-term call option, I can sell these shares at a price of 60. So that is going to make a profit for me, at least in regards to the shares. So now I add to this 60, which means I'll profit ten bucks per share times the 100 shares. That's an overall profit of $100. Very nice. And on top of this, I also get to keep the premium from selling this call option. And so if I initially sold it for about 150 bucks in credit, I now just add it to my profits here. So 1000 plus 150 is a total profit of one hundred, one hundred and fifty bucks. So this might sound very nice, but again, don't forget, I initially paid one hundred, two hundred to buy the longer-term option in the first place. So from this, I subtract 1200 and in the end, I have to walk away with a loss of 50 bucks. Not a big deal, but still a loss nonetheless. So what does this mean? Means I will have to sell my call option, my shorter-term call option, with a higher strike further away from 60 bucks per share. So for example, if I instead sold the 65 strike collection here for only about 50 bucks, which might not sound that great. In the end, if I dig it assigned on this contract, I would actually walk away with an overall net profit. So one more time, given the calculator back during the screen, if by the expiration date, Twitter was at 65 bucks per share, right at my short call strike, and I got assigned on this contract. Once again, I'll exercise my long-term collection down here and buy those shares for 50 bucks per share. Then to honor my agreement, I can sell them at a price of 65 bucks per share. So that's an overall profit of 15 bucks per share times 100. I now make 1500 bucks just from trading the shares. And on top of this, again, I get to keep the credit I sold the shorter-term collection for which was about 50 bucks. So the total profit is one hundred, five hundred and fifty bucks. So now when I subtract the cost of that longer-term contract of 1200, the net effect is I still make 350 bucks. So this is the main additional thing you need to be aware of for the poor man's variant of the cover call and also cover put strategies because you also have this extrinsic value concept thrown in the mix, you must keep that in mind when putting on the strategy here. So before you sell your short-term option against your longer-term option, go through this process, makes sure that if you do get assigned on your short-term option and you're forced to exercise your lung option early, you'll still walk away with a profit or at least a scratch. Now of course, if you don't get assigned on your short-term option, right? Perhaps by June 18th, Twitter only moves from 58 to 63 bucks per share. Well, that means this collection would still be out of the money and it will just expire worthless. And I would keep the full 50 bucks and credit isolated call option for initially. And at that point, my longer-term option will still have plenty more time lift and go until its expiration date. So I can just repeat the process right. Once my June option expires worthless, I can just go into the July expiration cycle and sell a call option in here. And then once again, if my July call option expires worthless, I will then just go into the August expiration cycle and repeat the process over and over and over again, collecting more and more credit. And you definitely want to keep track of the total credit you have collected along the way. Because the more credit you collect, obviously the more money you'll have to offset losing the extrinsic value on your lung option. Should you have to either exercise that option early or the process of time decay, right? As you learned in the last video, the extrinsic value component of an option is the additional time value on top of the intrinsic value, Right? Well, as time marches on, as you get closer and closer to the expiration date, there's obviously going to be less time remaining and therefore less time value. So the extrinsic value of your contract is going to slowly deteriorate as time marches forward, right? This 50 strike call option that we initially bought at the beginning might be worth 1200 bucks today. But in three months, even if Twitter is at the exact same price, if it's still at 58 bucks per share, this color option will be worth significantly less. It will still have the same amount of intrinsic value, but the extrinsic value will be a lot smaller. And again, that's just because of the natural process of times slowly eating away at the extrinsic value. So ultimately, when you do buy a longer-term in the money call option, you want the stock to increase in price. But because options have an expiration date, because they also have extrinsic value. That means selling these shorter-term color options are going to be very, very useful to offset losses in the case that you are actually directionally wrong on the trade. If by December 17th, Twitter actually falls in price below 50 bucks per share, this call option is going to expire completely worthless and you will lose the full 1200 bucks that you paid for the option in the first place. But if you are collecting credit along the way from continuously selling shorter-term call options against this one, your losses will be substantially less. So I believe that's gonna do it here for the poor man's covered call. It really is very similar to the regular covered call. You just have to do some extra careful planning to factor in the extrinsic value component of options. So thanks for watching. And in the next video, we'll take a look at the poor man's cover, put. 5. The Poor Man's Covered Put: Okay, welcome back to the final lesson in this course. And in this video here, we'll be taking a look at the poor man's cover put strategy now. So one more time we'll come over to the trade tab for Twitter. And so the poor man's covered PUT is going to be very similar to the poor man's covered call, except it's just the opposite, right? The poor man's covered call is a generally bullish strategy, or the poor man's covered put is a bearish strategy. So for any stock you find where you have a long-term it bears assumption you think the stock is going to be going down over the next few weeks and months, then this would be a great candidate for a strategy. So once again, we'll take a look at the December expiration cycle to keep things consistent. But now instead of looking at the calls, we're going to look at the put options. And so we're going to focus on the 70 strike put option here. It has a 68 delta, which is a little bit low, right? Generally I would say to keep above a 70 Delta, but this is certainly close enough. And I also do want to keep in mind the amount of money I will be spending for buying this option, right? Because even though a higher delta means that option will behave more like stock, you're going to be paying a much higher price for these options. So you do want to find the right balance between a pretty high Delta and also a relatively cheap cost for the option. And with the seventh district put option here trading for about 1600 bucks, that's definitely a pretty reasonable price. So this would be step 1, buying this put option here. And then step 2 would be to sell a put option with a closer exploration cycle with a lower strike. So we could go into the June expiration cycle again, but the cycle as of today expires in only about two weeks. There's nothing inherently wrong with selling options pretty close to the expiration date, but I do like to collect a pretty decent credit for the options I'm selling. And the best way to do that is to sell those options with a bit more time baked in. So perhaps I'll go into the July expiration cycle with 43 days left to go. And so looking at these put options now, perhaps I want to sell the 52.5 strike put for around 130 bucks in credit. But before I click send on this order, I need to check to make sure that if I do get assigned on this contract, and therefore I must exercise my long put option early. I need to make sure I will still walk away with a profit. Or in the worst case, just break-even. And so again, it's going to come down to figuring out how much extrinsic value is in my long put option. Because if you recall that extrinsic value, if I have to exercise this option early, I will lose that amount of money. But if I make more than that amount through the assignment process, then that's fine. I'll still walk away with a profit. So one more time, Let's get the calculator and do some basic math. So if my long put option has a strike, current trading price of Twitter is running down by one penny. If the current price is 57 bucks per share, then I just take 70 minus 57, which gives me $13 of intrinsic value per share in this contract. So times the 100 shares overall, that's an intrinsic value of one hundred, three hundred dollars. Now if we subtract from this, the actual trading price of the contract, which like I said, is around 1600 bucks. So we subtract 1600. And that means there is $300 of extrinsic value in this option, and this is the amount of money you will lose if you'd have to exercise your long option early. So now let's say fast-forwarding time to the July expiration date. Let's say Twitter falls in price from 57 down to maybe 50 bucks per share. So it's below the strike of our shortcut option contract That will be sold, and therefore it's very likely will get assigned on this contract. Now keep in mind what it means to be assigned on a short put option. When you sell a put, you're obligated to purchase 100 shares of the stock at the strike price. And then for our lung put option, because we are the buyer of this contract, that means we have the right to sell those 100 shares at a price of 70 bucks per share. So through this process, you will make a profit from trading the stock because it gets a below and then sell at a much higher price. So now clearing the screen, we first have to buy those shares at $52.50. So that will cost money. And then through exercising our lung put option early, we can turn around and sell those shares at a price of 70 bucks per share, which creates a profit of $17.50 per share times the 100 shares. That's an overall profit of 1750 bucks. Very nice. And on top of this, don't forget also, you get to keep the full credit. You sold the put option four, which was 130 bucks. So finally, we add 130, and that means the total profit is one hundred, eight hundred and eighty bucks. And then from this amount we finally have to subtract the cost of that put option contract that when we bought initially. So we subtract 1600, which in the end leaves us with a profit of 280 bucks. And so this includes having lost, having forfeited that 300 bucks in extrinsic value from our long put option contract, right? Otherwise, if we didn't have to forfeit that amount, then this would actually be a profit of $580. But again, because there's always going to be extrinsic value in those contracts and you will always lose that as a buyer of an option. That's why the actual total profit here is only 280, but it's still a profit nonetheless. And again, keep in mind, this would be the scenario. If you've got assigned on the very first put option you sold against your lung put option. If this one expired, worthless if by July 16th, Twitter was above the strike price, well, you just walk away, keep the full 130 bucks and credit. And you can do it again. Right. You would then go into the August expiration cycle and cell another put option in here, and then again in September, again in October, again in November, and one more time in December. Each time you do that, you sell a put option for around 130 bucks. That could easily be six or 700 bucks in total, in total credit that you have collected along the way. Now again, don't forget about time decay though, which will impact your lung, put option negatively. So as time marches forward through July, August, September, October, and so on, the extrinsic value of your contract will slowly get eaten away. But again, if along the way you have in total collected more than that amount from just selling put options, selling shorter-term put options, then it won't matter. And then in the absolute worst-case scenario, if you are directly wrong on this trade. If by December 17th, the exploration of your long put option, if Twitter never actually sells off, perhaps it actually rallies and goes above your lawn. Put strike here. Well then you will lose the full value of this put option contract. You'll lose the full 6800 that you paid for it initially, which would definitely hurt if you only bought this put option and then did nothing else. However, if your total credit that you collected from selling all those shorter-term put options amounted to six or 700 bucks. Well, that's going to bring down your law substantially from 1600 down to maybe 900 or even less. And so there you have it. That's the poor man's covered put strategy. Both for this one and also the poor man's covered call. The most important thing to keep in mind is the extrinsic value. You will lose either from having to exercise your long option early and from the natural process of time decay that will dictate which strike you select for that shorter term option that you sell against your longer-term option. Or at the biggest mistake you can make with these kinds of strategies is not taking that into account. Selling your short-term option, then getting assigned on it and realizing that you're actually going to walk away with a loss. And so with that said, that's going to conclude this video, and I'll see you one more time in the next video just to wrap some things up and then I'll send you on your way. 6. Wrapping Up: Okay, congrats on finishing this course, and by now, you should have everything you need to know to start trading the poor man's covered call and cover put strategies. And to help you get started with that, you can take a look at the course project down below. And so with that being said, thank you so much for watching this course. I am Scott race again, and I do appreciate any and all feedback that you may have. Moreover, if you've got questions or if you need clarification on something, please drop a comment in the discussion section of this course below, and I'll get back to you as soon as I can. And I also encourage you to check out my other classes on Skillshare. I've got a lot of other content on options trading, stock market investing, and a few computer science topics as well. And finally, don't forget to check out and subscribe to my new YouTube channel and also follow me on Skillshare platform here so that you'll get notified every time I publish a new course. So thanks again for watching and happy trading.