Income Math with LEAPS: Basis Reduction, Yield on Capital, and Realistic Expectations

Most people fall in love with LEAPS income strategies for one reason: they feel like discovered leverage.

Instead of tying up $18,000 to buy 100 shares outright, you spend perhaps $4,000 to $8,000 on a deep-in-the-money LEAPS call, then sell short-term calls against it as if you owned the stock. That's the Poor Man's Covered Call in plain terms, a covered call structure built on borrowed time rather than actual shares.

The mechanics are straightforward enough. But the strategy doesn't become real until you can answer three questions with actual numbers: How much have we genuinely reduced our cost basis? What yield are we earning on the capital we've actually deployed? And what should we realistically expect without indulging in fantasy projections?

Let's build a framework you can apply consistently, month after month.

The Three Numbers That Matter

Net Debit

Your net debit is the cost of the LEAPS minus any premium collected at entry. Most traders track what they paid for the LEAPS and stop there. That's insufficient. In a PMCC structure, your true cost basis evolves over time because you're continuously collecting, and sometimes returning, premium through the short call overlay.

Think of net debit as the outstanding balance on a loan. It's what you still have at risk after accounting for all premium activity.

Basis Reduction

Basis reduction is the cumulative net premium from your short calls after accounting for buybacks, rolls, and adjustments. If you sell a call for $1.20 and buy it back for $0.25, your net premium for that cycle is $0.95, or $95 per contract.

That $95 isn't merely income in the traditional sense. It's basis reduction, it lowers what you've effectively paid for the LEAPS position over time. If you execute ten similar cycles, you haven't simply "made $950." You've reduced your effective LEAPS cost by $950, which fundamentally alters your risk profile.

Yield on Capital

This is where most traders accidentally deceive themselves. Yield on capital measures net premium collected divided by the net debit you've actually deployed. If your LEAPS cost $5,000 and you collect $1,000 in net premium over a period, your yield on capital is 20%.

That's meaningful because it's measured against the capital you actually used, not some notional stock value. But the trap comes next, annualizing that return as if it's guaranteed, smooth, and infinitely repeatable. It isn't.

A Realistic Example With Clean Numbers

Consider a stock trading at $180. You structure a classic PMCC by purchasing a deep in-the-money LEAPS call with roughly 0.80 delta for $50.00, or $5,000 total. Each month you sell a short call around 0.25 to 0.35 delta. Over six months, you complete six call cycles.

Using conservative, realistic assumptions, here's what the math might look like:

Each month you sell the call for $1.10 and later buy it back or roll it for $0.30, producing net premium of $0.80, or $80 per cycle. Over six months, that's $80 multiplied by six cycles, totaling $480 in net premium collected.

What have you accomplished? You've achieved $480 in basis reduction. Your six-month yield on capital is $480 divided by $5,000, or 9.6%. If you annualize that figure, it suggests roughly 19% to 20% annually.

But notice what we haven't assumed. We haven't assumed perfect fills at mid-price every time. We haven't assumed uninterrupted premium selling without defensive adjustments. We haven't assumed volatility remains constant or that getting assigned early never complicates the plan. That restraint is what makes this projection realistic rather than promotional.

The Basis Reduction Ledger You Should Actually Track

Most traders track PMCC profit and loss the way they'd track a stock position. That's a category error. A PMCC behaves more like a small business operation. Your LEAPS is the capital equipment. Your short calls generate monthly revenue. Your roll losses and adjustments are operating expenses.

Here's a clean tracking method. Start with your initial LEAPS cost, say, $5,000. Each month, add the short call credit you received, subtract the cost to close or roll that short call, and calculate the net premium for that cycle. Then update your effective basis by subtracting cumulative net premium from the original LEAPS cost.

After six cycles in our example, your LEAPS cost remains $5,000, but you've collected $480 in net premium. Your effective basis has dropped to $4,520. That's not just psychological comfort. It's the core economic engine of the strategy, you're systematically lowering your breakeven while maintaining long exposure.

The Uncomfortable Truth About Income

A PMCC can generate income, sometimes substantial income. But that income isn't free. It arrives with three built-in trade-offs.

First, you're short convexity on the upside. The short call functions as your income engine, but it simultaneously caps your upside participation. When the stock rallies hard, you feel the constraint. The LEAPS provides some buffer through its higher delta, but the short call can still become a management problem quickly.

Second, the income isn't stable. Premium varies with implied volatility, realized volatility, trend strength, earnings cycles, and broader market conditions. Some months deliver excellent premium. Other months you barely collect anything worthwhile. Some months you're forced to roll for a debit just to maintain the structure.

Third, annualized yield figures are often marketing fiction. If you generate 3% on capital during a high-volatility month and annualize that to 36%, you've created a number, not a plan. A genuine plan survives the bad months without requiring you to abandon the strategy.

Why LEAPS Basis Reduction Works, When It Works

This is what makes PMCCs elegant when executed properly. Your LEAPS typically carries a delta between 0.75 and 0.90. Your short call typically carries a delta between 0.20 and 0.35. When the underlying rises, the LEAPS tends to gain value faster than the short call loses value, at least initially. That delta spread is your structural advantage.

But delta isn't static. As the stock pushes higher, your short call delta rises, sometimes rapidly, until it begins behaving like stock itself, approaching a delta of 1.00. That's why having clear roll rules matters more than having strong directional opinions. The math changes on you whether you notice or not.

A Realistic Expectations Framework

If you want to set expectations professionally, stop asking "What percentage can I make per month?" Start asking better questions.

First, what market environment are we operating in? During low-volatility grinding bull markets, income will be smaller, rolls more frequent, and managing the upside more critical. During high-volatility choppy markets, income may be larger, but drawdowns and whipsaws become real concerns. In bear markets, call income helps cushion losses, but you're still carrying long exposure through the LEAPS itself.

Second, what's our realistic sellable premium range? For many liquid underlyings, major ETFs and large-cap stocks, a reasonable expectation for monthly short calls might be 0.5% to 3% of LEAPS cost in net premium, depending on implied volatility and strike selection. Not every month. Not guaranteed. But a sane planning range that accounts for real market behavior.

Third, what's our rule when things go wrong? Because they will. You need clearly defined protocols for when the stock rips through your short strike, when the stock drops and volatility spikes, for earnings week complications, for when bid-ask spreads widen uncomfortably, and for when you're forced to choose between rolling at a loss and resetting the entire position.

If you can't describe your defensive protocols in two sentences, your expectations are too optimistic.

The Practical Playbook: Keeping the Math Honest

Step 1: Buy the LEAPS like you're acquiring a business asset

For most PMCCs, useful filters include a delta around 0.75 to 0.85, expiration between 9 and 18 months out (though 12 to 24 months often works well), and modest extrinsic value. As a rough guideline, many traders try to avoid paying excessive time premium relative to intrinsic value. The objective is owning something that behaves like stock without overpaying for time decay you don't need.

Step 2: Sell short calls with a repeatable delta

A common range is 0.20 to 0.35 delta, adjusted for trend strength and volatility environment. Use expected move as a sanity check for strike placement, not as a crystal ball.

Step 3: Harvest premium like a risk manager

A simple, repeatable framework: Take profits early when they're available rather than waiting for maximum decay. Avoid letting short calls migrate from "income generators" to "management problems." Make roll decisions based on pre-established rules, not emotional reactions to market movement.

Step 4: Track basis reduction every cycle

If you don't track this systematically, you'll overestimate performance and underestimate risk exposure. This isn't optional record-keeping. It's core position management.

Step 5: Evaluate success correctly

A PMCC generates returns through two streams, LEAPS appreciation or depreciation, and short call net premium. Effective management means you're not blind to either component. Don't let a string of successful short calls distract you from deteriorating LEAPS value, and don't let LEAPS gains tempt you into sloppy short call selection.

A Quick Reality Check

Before labeling any PMCC "excellent income," verify these points:

Are you actually reducing basis net of all rolls and buybacks, or just collecting gross premium? Are you comparing income to net debit deployed, not to the notional stock price? Are you assuming you can sell calls every month without interruption or defensive adjustments? Do you have clearly defined rules for sharp rallies, and separately, for earnings weeks? Is your position size small enough that one adverse move doesn't paralyze your decision-making?

If any answer is no, recalibrate your expectations accordingly.

The Goal Isn't Maximum Yield

The goal is durable yield, income you can generate consistently without taking unmanageable risks or requiring perfect market conditions.

The PMCC isn't magic. It's simply an intelligent trade-off: less capital than outright stock ownership, a disciplined income overlay through short calls, and a basis reduction mechanism that compounds quietly over time when managed properly.

If you maintain honest accounting, tracking net premium, basis reduction, and yield on deployed capital, you stop chasing the idealized version of the strategy and start executing the real one. And the real version, executed with discipline, is good enough.

That's not a compromise. It's the difference between sustainable income and eventual disappointment.

Probabilities over predictions,

Andy

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Disclaimer: This is educational content only. Not investment, tax, or legal advice. Options involve risk and aren't suitable for all investors. Examples are illustrative. Real results will vary. Talk to professionals before you risk real money.