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Which LEAPS strike should the long leg be?
Pick the long call too shallow and the trade is cheap, tracks the stock badly, and can be capped at a loss before the stock moves at all. Here is the arithmetic that decides the strike for you.
The one rule, first
A poor man's covered call is a long-dated call (a LEAPS) plus a short nearer-dated call sold against it. The long call stands in for the 100 shares a real Covered call needs. It is a diagonal spread with a nickname.
Everything about picking the long strike comes back to one line:
Most the trade can make = (short strike − long strike) × 100 − net debit paid.
If the short strike is below the long strike plus the debit, that number is negative. The trade is capped at a loss from the start, no matter how high the stock goes. That is not a risk. It is already done, the moment you open it.
Flip it around and you get the number you actually need:
Lowest short strike that is not an instant loss = long strike + (net debit ÷ 100).
Write that number down before you sell a single call. If the strikes you want to sell sit below it, the long leg is wrong.
A worked comparison (hypothetical)
An illustration, not a trade idea.
Made-up company Riverbend Tools trades at $50. Buying 100 shares costs $5,000.
Five possible long legs, all 14 months out. In every row you then sell the same short call: a 30-day $55 call for $1.00, which brings in $100.
Net debit = what the long call cost, minus that $100.
| Long strike | Delta | Long call cost | Time value in it | Net debit | Width to $55 | Lowest safe short strike | Most the cycle can make |
|---|---|---|---|---|---|---|---|
| $30 | 0.95 | $21.50 | $1.50 | $2,050 | $2,500 | $50.50 | +$450 |
| $35 | 0.90 | $17.00 | $2.00 | $1,600 | $2,000 | $51.00 | +$400 |
| $40 | 0.85 | $14.00 | $4.00 | $1,300 | $1,500 | $53.00 | +$200 |
| $45 | 0.75 | $10.00 | $5.00 | $900 | $1,000 | $54.00 | +$100 |
| $50 | 0.60 | $7.50 | $7.50 | $650 | $500 | $56.50 | −$150 |
Read the last row. The cheapest long leg, at $750, is the only one where a $55 short call caps the trade below what it cost. The stock can run to $80 and the best outcome is still minus $150.
Check it by hand. Stock ends at $60, the short $55 call is assigned, you exercise the long call to deliver: buy 100 at $50 for $5,000, sell them at $55 for $5,500, so +$500. You paid $750 for the long call and took in $100, so you are $650 down on the legs. $500 − $650 = −$150. The formula and the cash agree.
Do the same on the $40 row: buy at $40 for $4,000, sell at $55 for $5,500, so +$1,500, against a net debit of $1,300. That is +$200.
How deep is deep enough
Delta in plain words is how much the call moves for each $1 the stock moves. For a long leg standing in for shares, most people want 0.75 to 0.85. Below about 0.70 the call stops behaving like stock.
| Long leg | What you get | What it costs you |
|---|---|---|
| Very deep (delta 0.90+) | Tracks the stock closely, almost no time value to earn back | Biggest cash outlay, closest to just buying shares |
| Deep (delta 0.75–0.85) | Moves most of the way with the stock, modest time value | A real price tag, usually a third to a half of the shares |
| Near the money (delta 0.55–0.65) | Cheapest entry | Huge time value to earn back, bad tracking, and the width rule starts failing |
Notice the time-value column in the big table. The $50-strike long leg holds $7.50 of pure time value. The $40-strike holds $4.00. The $30-strike holds $1.50. Every cent of time value is money you must earn back from short calls before the trade is even flat.
The trap of a long leg too cheap to survive a drop
The shallow long leg has a second problem that the width rule does not show: it falls apart when the stock drops.
Same company, three months later. Riverbend Tools has slid from $50 to $42. The long legs now have 11 months left.
| Long leg | Paid | Worth now | Loss | Share of your money gone | Delta now | Calls you can still sell above your own strike |
|---|---|---|---|---|---|---|
| $40 strike | $1,400 | $700 | −$700 | 50% | 0.67 | The $45 call, about $0.70 |
| $50 strike | $750 | $300 | −$450 | 60% | 0.39 | The $50 call, about $0.10 |
The $50-strike holder lost less in dollars and is in far worse shape. Delta 0.39 means the call barely follows the stock back up. And the only strike at or above his own is the $50, which pays about $10 a contract. He is stuck choosing between collecting nothing and selling a call below his long strike, which caps the trade at a loss.
The $40-strike holder can still sell the $45 and $50 calls, both above his strike, and keep working.
How much time to buy
- A year or more. That is what makes it a LEAPS, and it is the point: decay is slow when expiry is far away. See LEAPS options explained for the decay curve.
- Not so far out that nobody trades it. Check the bid-ask gap and Open interest before you commit. A wide spread costs you twice, once in and once out.
- Leave at least six months when you plan to exit. The last three months are where the time value disappears fastest, and that is the part you cannot sell.
The capital and account question
A long leg a year out ties up real money in one company for a long time, and it is not shares — it pays no dividend and it can reach zero. Multi-leg spreads also need a higher options permission level at most brokers than plain covered calls do. In Canada, writing calls and running spreads inside a TFSA or an RRSP depends on the broker and may not be allowed at all, so check your broker's current options agreement before you plan around it.
If a plain covered call fits your account, it is the simpler trade. For the wider map, see option strategies beyond the wheel, and the wheel strategy for the share-based version.
Your checklist before you open one
- Pick the long strike at a delta of 0.75 or better. Note its cost and its time value.
- Note the short call you intend to sell, and the credit.
- Net debit = long cost × 100 − credit.
- Lowest safe short strike = long strike + net debit ÷ 100. If your short strike is under that number, stop.
- Most the cycle can make = (short strike − long strike) × 100 − net debit. Write it next to the max loss, which is the net debit.
- Run both through the options strategy payoff calculator before you place anything.
Questions
What delta should the LEAPS be in a poor man's covered call?
Most people use 0.75 to 0.85. That is deep enough to follow the stock closely while still costing much less than 100 shares. Shallower strikes hold more time value and track the stock badly.
How do I know if my PMCC is capped at a loss?
Work out (short strike − long strike) × 100 − net debit. If that is negative, the trade cannot make money even if the stock runs, because assignment locks the result at that number.
Can I just sell a short call below my LEAPS strike for more premium?
You can, and it caps the trade at a loss if that call is assigned. The bigger credit buys a worse ceiling. See the stock fell below your LEAPS strike for how bad that gets.
Is a deeper LEAPS always better?
It tracks the stock better and holds less time value, but it costs more, so it eats more of your account in one name. Past about delta 0.90 you are close to paying share prices without getting dividends.
How long should the LEAPS have left when I close it?
Many people exit with six months or more remaining, because the final months are when time value drains fastest and a long-dated contract is easiest to sell while it still has time in it.
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