Leveraged covered calls with LEAPS

Discussion in 'Options' started by CaptainObvious, Aug 31, 2013.

  1. OK, a question to see if I understand this. I want to sell front month call options without owning the stock, but don't want to be totally naked. There is a strategy using LEAPS to be partially covered which is acceptable with some brokers at a Level 3 margin, which means I'm not really using margin, right?. TradeKing calls it the Figleaf.
    I understand the basics of it as it's easy enough. Buy some deep ITM LEAPS and then sell the front month a strike or two out. Collect, expires worthless hopefully. Rinse, wash, repeat. My question is about potential assignment.
    I know I can buy the calls back for a loss prior to getting assigned if the underlying is moving against me. But let's say it moves hard before I can make that trade, or, and this is the crux of the question, I just let it get assigned.
    "IF", I'm understanding assignment correctly I'll have bought the stock at the strike price I sold the call for. Right? So let's say I sold 20's and the stock was at 18. It blows though 20 and is at 20.50. I get assigned and now have purchased the stock at 20, right? So if I own at 20 and the current PPS is 20.50, I just turn around and sell the stock for 20.50 and make a profit, right? So long as I can cover that purchase of the assigned shares, and make that trade before the PPS falls back below 20, WTF do I care if I get assigned? There is zero possibility of me getting assigned prior to the PPS moving through 20, right? And I still own the LEAPS, right? Which in theory will be worth more, right?
    Am I missing something here?
    BTW, I know there is the possibility of the LEAPS losing their value and at some point the need arises to start managing that trade, but that's a different subject. At this point I'm just concerned about assignment.
    Thanks in advance for any help.
  2. A call is the right to buy, so if you sell a call someone else has the right to buy the stock at the strike price.

    So if you sell a call that is exercised, you will be short the stock.
  3. OK, I did not understand what assignment really meant. Thanks.
  4. And I guess I still don't get this. What's throwing me is under this scenario I don't actually own any shares, I just have a DITM LEAP.
    Let's say I just bought a AAPL Jan15 415 Call for 100, which is a 10,000 bucks out of pocket. Now I sell a Sept13 520 Call and collect the 400 bucks for doing that. It's all good and I'm hoping AAPL doesn't make the move to 520 before expiration. But let's say it does make that move. I get assigned, but I don't own the shares, I just own this LEAP. How much money exactly do I need to end this trade? If I don't own the shares, and don't have 52,000 dollars in my account, and I'm not on margin, and selling my LEAP, while it has increased, sure as hell isn't going to cover the price of actually buying 100 shares, why is a broker allowing me to make this trade? Where is the money going to come from?
    OR, do I just need the difference between the exercise price of 520 and whatever the current PPS is? Say the call was exercised with the PPS being at 525. I'm short and down 500 dollars, but I don't have any shares to deliver as with an actual covered call. Do I just need 500 dollars to get out of this trade, or do I need 52,500? I know this must sound idiotic, but I can't find a clear cut answer to this anywhere.
  5. newwurldmn


    You need the 50,000 to hold the trade.

    You will be bought in and the gain/loss will be absorbed by your account.

    This is a bad way to trade.
  6. Which is what I thought, but why in the world would a broker allow a person to make this trade if that person had no where near that in an account? On the TradeKing site it implies someone can make this trade without any margin.
    I know the trade can be managed and if done properly should never get to the point where it would be assigned. One would just bail out or roll it. I was just curious about the worst case scenario, and confused, (still confused) on how a broker could allow this trade without any margin requirements. Right from their site:

    TradeKing Margin Requirement

    After the trade is paid for, no additional margin is required.

    And this:

    Maximum Potential Loss

    Potential risk is limited to the debit paid to establish the strategy.

    NOTE: You can’t precisely calculate your risk at initiation of this strategy, because it depends on how the LEAPS call performs and the premium received for the sale of additional short-term calls (if any) at later dates.

    No where does it say one would need enough money in an account to cover assignment. Just that you'd have to buy the stock to cover your new short position. Buy it with what? Selling the LEAPS sure as hell isn't going to cover the cost of buying the shares.

    Read more at: http://www.optionsplaybook.com/option-strategies/leveraged-covered-call/#ixzz2deNlICP2
  7. "IMPLIES" is the operative word...Newwurld is exactly right. You need lots of money for this lousy way to trade. LEAPS are usually overpriced anyway because they are so far out. Its always tempting and if the stock does EXACTLY what you project and your management of the trade FLAWLESS only then will it be worth it.
  8. newwurldmn


    Because you can close out before expiry.

    A long leap and short stock is a different trade than a calendar spread regardless of how you get to the position.
  9. I appreciate the input. I was just looking for a new broker as I want to reduce my commissions when trading options. As I came across TradeKing I noticed their educational resources and blog so I started reading this strategy. I familiar with and have traded with covered calls, but never knew of this. On face value it sounded great. One can establish a position to sell calls and not have so much capital tied up while doing it. Fantastic! Digging deeper...not so much.
    Thanks again.