Poor Man's Covered Put

A "poor man's covered put" is a trading strategy that mimics the payoff of a covered put but with a lower capital requirement. This strategy involves using a long-term put option (often a LEAPS option) as a substitute for shorting the underlying stock, and pairing it with a near-term short put option. The short put is intended to generate income from extrinsic value premium.

This strategy is considered more cost-effective than a traditional covered put because it doesn't require shorting the underlying stock, which can be capital-intensive. It also offers the advantage of defined risk, because the maximum potential loss is limited to the net cost of the long put minus the premium received from the short put (e.g. the net debit) 

Ideally, the longer-dated put in a poor man's covered put will serve as an anchor and asset in the trade, allowing the trader to sell additional near-term puts against it if the initial short put expires worthless. This theoretically generates additional income over time, helping to reduce the initial cost of the spread, and potentially contributing to greater overall profits. Ideally though, the stock price decreases and increases the value of the long put contract and overall spread, even if that means a “loss” on the short put contract in isolation.

DIRECTIONAL ASSUMPTION

Bearish

IDEAL IMPLIED VOLATILITY ENVIRONMENT

Low

PROFIT/LOSS CHART

The poor man's covered put is versatile and can be used effectively in both bearish and moderately flat market conditions, offering income generation and downside exposure. For a bearish outlook, the long-term put provides downside exposure as its value increases if the stock price falls, allowing the trader to benefit from the decline. 

Alternatively, for an investor/trader that expects sideways movement in the underlying, the strategy works by generating regular income from selling short-term puts. If the stock price remains above the short-term put strike price, these puts will expire worthless, allowing the trader to keep the premiums and sell additional short-term puts over time. In this scenario, the long-term put serves as a slowly decaying asset, but still provides downside exposure to the  market.

More details on how these positions work is detailed below.

Buy a Longer-Term Put Option

• The first step is to buy a long-term put option, such as a Long-term Equity Anticipation Security (LEAPS) option. 

• The long-term put is usually at-the-money (ATM) or in-the-money (ITM), depending on investor/trader’s market outlook and risk profile. This long put position serves as a stand-in for shorting the stock, as compared to a traditional covered put strategy. By owning this put, the investor/trader gains downside exposure in the stock or ETF for a prolonged period in a defined risk way.

• The strike price of the longer-dated long put will typically be higher than the strike price of the near-term short put. This ensures that the long-term put provides sufficient downside exposure, and retains more intrinsic value in the event of a sell-off in the underlying stock. 

Sell a Near-Term Put Option

• The second component of a poor man’s covered put is to sell a put option with a much shorter expiration date than the long put. The short put is typically out-of-the-money (OTM). 

• By selling this put, the investor/trader collects extrinsic premium, which is the income component of the strategy. Ideally the underlying stock price settles above the strike price of the short-term put at expiration, and the put expires worthless, allowing the investor/trader to keep the premium received. 

• The strike price of the near-term put is usually lower than the strike price of the longer-dated put to ensure that the longer-term put provides adequate downside exposure, and retains more intrinsic value in the event of a correction in the underlying stock. 

A poor man's covered put differs from a traditional covered put in several key aspects, primarily relating to the structure, capital requirements, and risk profile. The key differences between these two positions are outlined below.

Traditional Covered Put

Structure

• Involves short selling the underlying stock and simultaneously selling a put option on that stock.

• The short put option’s risk is “covered” by the 100 shares of short stock that would offset intrinsic value risk below the short put.

Capital Requirement

• Requires significant capital due to the short stock component, which involves borrowing the stock and selling it in the open market.

• Margin requirements can be substantial due to the risks associated with undefined risk.

Risk Profile

• Potentially unlimited risk if the stock price rises significantly, as there is no upper limit to how much a stock price can increase.

• The profit potential is limited to the premium received from selling the put plus any decline in the stock price down to the strike price of the put.

Associated Outlook

• Suited for a bearish market outlook, as profit is maximized if the stock price declines.

Learn more about the traditional covered put.

Poor Man's Covered Put

Structure

• Involves buying a longer-term put option and selling a near-term put option.

• The longer-term put option serves as a substitute for the short stock position in a traditional covered put.

Capital Requirement

• Requires less upfront capital compared to traditional covered puts, because you are dealing with owning an option instead of short selling a stock.

• The primary cost is the net expense of the long-term put option less the premium received from selling the short-term put.

Risk Profile

• The maximum risk is limited to the net debit paid for the spread, and is defined as the cost of the long-term option less the premium received from the short put. 

• The profit potential if the spread is ITM is estimated at the width between the long and short option, less the debit paid up front, with the addition of any remaining extrinsic value in the long option at the short option’s expiration. The best case scenario for this strategy is if the stock price drops quickly after entering the trade.

Associated Outlook

• The poor man's covered put is versatile and can be used effectively in both bearish and moderately flat/sideways market conditions. 

Much like other options-related strategies, investors and traders should carefully analyze market conditions, as well as their own outlook, when deciding whether to manage or close a poor man’s covered put.

Some of these considerations are outlined below.

Managing the Position

• Risk Management: Always be aware of your maximum potential loss and have a plan if the trade moves against you. This might involve setting stop-loss levels, or deciding in advance under what conditions you will close the position to prevent further losses.

• Monitoring the Underlying Stock: Keep a close eye on the performance of the underlying stock. If your market outlook changes, or if the stock moves in an unexpected direction, be prepared to adjust your position accordingly.

• Rolling the Short Put: If the short put is approaching expiration and you wish to maintain or adjust your position, you might consider rolling the put. This involves buying back the current short put and selling another put with a later expiration date, and possibly a different strike price. This strategy can be used to generate additional premium income, or to adjust one’s market view.

• Consider Time Decay: Options are time-sensitive instruments. As time passes, options lose value, which may be detrimental to the longer-dated put position. Be mindful of this in your management strategy.

Closing the Position

• Buy Back the Short Put: If the short put option you sold loses value, you can buy it back at a lower price than you sold it for. This action closes the short leg of the spread. After closing this position, the investor/trader may elect to sell another put in another near-term expiration period, depending on his/her market outlook and risk appetite. 

• Close Both Legs Simultaneously: In some cases, it may be prudent to close both legs of the spread at the same time if the position quickly moves and the trader looks to secure profits or reduce losses. Most spreads are closed in this fashion, to help minimize the risk associated with naked options positions leftover if just one strike is closed. 

The poor man's covered put may be suitable for investors and traders with a bearish outlook on a stock or ETF, offering a more capital-efficient alternative to traditional covered puts. However, the choice to deploy a poor man’s covered put will ultimately hinge on the trader’s unique market approach, market outlook and risk profile. 

The poor man's covered put is versatile and can be used effectively in both bearish and flat/sideways market conditions. 

tastylive approach

Maximum Profit

• With a poor man’s covered put, the maximum profit is a bit of a moving target, because it will depend on how much extrinsic value remains in the long put at the short option’s expiration

• Additionally, the maximum profit will also hinge on the profit/loss stemming from the longer-dated put position relative to the stock price. For example, if the longer-dated put has appreciated considerably in value and the stock price has dropped below the short option’s strike price, that could contribute to additional profit.

• Max profit for a fully ITM poor man’s covered put is the width of the spread, less the debit paid up front, plus any remaining extrinsic value in the long option at the short option’s expiration. 

Maximum Loss

• The maximum loss for a poor man's covered put is limited to the initial net debit (cost of the long-term put minus the premium received from the short-term put). For example, assume the underlying stock rises significantly in value, and renders both put options worthless. In this scenario, the maximum loss is the net debit paid to establish the position. 

The exact maximum profit potential & breakeven cannot be calculated due to the differing expiration cycles used. However, the profit potential & breakeven area can be estimated with the following formulas.

A hypothetical example of a poor man’s covered put is outlined below.

Step 1: Buy a Longer-Dated Put Option

• Action: You buy a long-term put option with a strike price of $95, expiring in one year. This option costs you $9 per share (remember, each option contract typically represents 100 shares, so the total cost is $900 for one contract).

Step 2: Sell a Near-Term Put Option

• Action: You then sell a put option with a strike price of $85, expiring in one month. For this option, you receive a premium of $2 per share (or $200 for one contract).

Net Debit

• Calculation: Your initial net outflow is the cost of the long-term put ($900) minus the premium received for the short-term put ($200), totaling $700.

Potential Scenarios

• Stock Price Stays Above $85: If the stock price remains above $85 at the expiration, the near-term short put expires worthless. You keep the $200 premium. You can then choose to sell another near-term put in a future near-term expiration period to continue the strategy.

• Stock Price Falls Below $85: If the stock price falls below $85, the near-term put might be exercised, requiring you to buy the stock at $85. However, your longer-term put covers your downside risk in this scenario.

Maximum Profit

• This isn’t precisely defined, because it depends on if the investor/trader can continue to sell short puts against the longer-term “anchor” put position. For example, in the initial position, if the stock remains above $90 at expiration, the trader can collect the full $200 in premium. But the trader might then elect to sell another near-term put in the another expiration cycle, which may result in additional profit.

• Additionally, the maximum profit will also hinge on the profit/loss stemming from the longer-dated put position. For example, if the longer-dated put has appreciated considerably in value, that could contribute to additional profit. It’s impossible to know how much extrinsic value remains in the long option at the short option’s expiration though.

• In this example, we know the entry cost is $7.00 on a $10 wide spread though, so if the stock drops below $85 at the expiration of the short put option, the max profit would be at least $300 + any remaining extrinsic value in the long option.

Maximum Loss

• For a poor man’s covered put, the maximum loss is the net debit paid to establish the position (cost of the longer-dated put minus the premium received from the near-term put). In this example, that is $700. 

A poor man's covered put is a strategic, defined risk options trading approach designed to replicate the payoff of a traditional covered put while requiring significantly less capital. This strategy involves buying a long-term, ATM the ITM put option (potentially a LEAPS option) which acts as a substitute for shorting the underlying stock. 

With a poor man’s covered put, the longer-dated put is then paired with a near-term short put, which is intended to generate income. By using a long-term put as an anchor, traders can achieve the same downside benefit as shorting the stock, but without the substantial capital requirement and margin risk associated with traditional short positions.

The versatility of the poor man's covered put allows it to be used effectively in both bearish and flat market conditions. In a bearish market, the long-term put would increase in value at a greater rate than the short put, providing protection against losses stemming from the near-term short put. 

Alternatively, in a moderately sideways market, the investor/trader may elect to sell additional puts in successive near-term expirations. By continuously selling short-term puts against the longer-term “anchor,” investors/traders can theoretically capitalize on recurring income opportunities, while maintaining a protective hedge against a possible correction in the underlying shares.