What Is a LEAPS Covered Call?
A LEAPS covered call (also known as a poor man's covered call or diagonal spread) involves buying a long-term deep-in-the-money LEAPS call option and selling short-term call options against it. Instead of owning 100 shares of stock for each covered call contract, you own a LEAPS option that behaves similarly to stock ownership but requires significantly less capital. This strategy allows you to generate covered call income with 60-70% less capital than traditional covered call writing.
LEAPS (Long-term Equity Anticipation Securities) are options with expiration dates one to three years in the future. When you buy a deep ITM LEAPS call (typically with a delta of 0.80 or higher), the option moves nearly dollar-for-dollar with the stock. This LEAPS acts as a stock substitute, and you sell short-term calls against it just as you would against shares. The key advantage is capital efficiency: instead of investing $10,000 to buy 100 shares of a $100 stock, you might spend $3,500 for a LEAPS that gives you similar exposure.
A traditional covered call on a $100 stock requires $10,000 (100 shares). A LEAPS covered call on the same stock might require only $3,500 (one deep ITM LEAPS). This 65% capital reduction means your return on invested capital is dramatically higher, though the risk profile is different.
How LEAPS Covered Calls Work
- 1Capital required = $35.00 × 100 × 2 = $7,000
- 2Capital for shares would be = $100 × 100 × 2 = $20,000
- 3Capital savings = 1 - ($7,000 / $20,000) = 65%
- 4Monthly income = $2.50 × 100 × 2 = $500
- 5Max profit per cycle = ($105 - $70 - $35.00 + $2.50) × 100 × 2 = $500
- 6LEAPS breakeven = $70 + $35.00 = $105.00
- 7Annualized return = ($500 / $7,000) × (365/30) = 86.9%
LEAPS Selection Guidelines
| LEAPS Parameter | Recommended | Why |
|---|---|---|
| Delta | 0.80 or higher | Moves nearly 1:1 with stock, minimizes extrinsic value risk |
| Expiration | 12-24 months out | Enough time for multiple short call cycles |
| Strike depth ITM | 20-30% below stock price | Ensures high delta and minimal time value loss |
| Extrinsic value | Less than 15% of LEAPS cost | You want mostly intrinsic value (acts like stock) |
| Bid-ask spread | Less than $0.30 | Tight spreads indicate good liquidity |
Managing LEAPS Covered Calls
LEAPS Management Checklist
Risks Unique to LEAPS Covered Calls
- LEAPS can expire worthless if the stock drops significantly (unlike shares which always have some value)
- LEAPS time decay accelerates inside 90 days, eroding your investment
- LEAPS do not receive dividends, unlike share ownership
- Assignment on the short call requires careful management since you don't own shares
- Wider bid-ask spreads on LEAPS compared to shares mean higher entry/exit costs
- LEAPS are marked-to-market and can show large unrealized losses during stock dips
The short call strike must ALWAYS be above the LEAPS breakeven (LEAPS strike + cost). Selling below this level means you lose money even at maximum profit. If the stock drops and your breakeven is above available strikes, you cannot sell short calls profitably and should consider closing the position.
Understanding Risk Management in Options Trading
Effective risk management is the foundation of long-term options trading success. Unlike stock investing where your maximum loss is your initial investment, options strategies can have complex risk profiles that require careful monitoring. Defined-risk strategies (spreads, iron condors, covered calls) have a known maximum loss before entering the trade, making position sizing straightforward. Undefined-risk strategies (short naked options) require understanding margin requirements and the potential for losses exceeding initial premium collected. All options traders should use the probability of profit (POP) metric — available on most options platforms — to understand the statistical edge before entering any trade.
Managing winning trades is as important as cutting losers. Research from tastytrade and other quantitative options firms shows that closing profitable short options positions at 50% of maximum profit significantly improves risk-adjusted returns compared to holding to expiration. The intuition: after capturing 50% of the premium, the remaining time risk (gamma risk near expiration) exceeds the potential reward. By closing early, you free up capital for new trades and eliminate the tail risk of a sudden reversal wiping out unrealized profits. This 'take profits at 50%' rule is one of the most robust findings in systematic options trading research.
