A LEAP Option Strategy For Generating Income

A covered call is a popular and conservative strategy that many investors employ to generate additional returns on their stock holdings. For every 100 shares of a stock in your portfolio you can sell one call against that security. In exchange for limiting your upside potential to the strike price of the call you’ve sold, you’ll collect income from the contract.

Percentage returns vary widely based on volatility and strike price, but even low-volatility out-of-the-money call writing can generate reliable double-digit returns.

You can implement a LEAP option strategy that replicates the effects of a covered call strategy with a lower capital outlay by using a diagonal spread. A diagonal spread can be used with any options, but when used as a LEAP option strategy, it typically involves buying a long-term LEAP contract on a security and subsequently selling shorter-term contracts against that same position.

This LEAP option strategy can be implemented in flat markets, bullish markets, or bearish markets, depending on whether you’re using call or put diagonal spreads. As you can tell from the chart below, we are in a textbook bull market right now (at least as measured by the large-cap S&P 500).

spx

This is considered a “textbook” bull market because the S&P 500 is consistently hitting higher highs while also experiencing higher lows. The index has also consistently found support at its (rising) 50-day moving average, which is another bullish indicator.

If we want to implement our diagonal spread LEAP option strategy, we’ll need to pick two contracts, a long LEAP call and a short call.

Diagonal Spread LEAP Option Strategy Step #1: Buying the LEAP

As previously mentioned, you can implement a diagonal spread on short-term options as well as LEAPs, but we’ll use LEAPs to maximize the time that we’ve got to apply the strategy. Specifically, we’ll be looking at the Jan. 20, 2023 SPY calls.

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