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+376 Part Ill: Put Option Strategies 
+er. More and more people are examining the potential of selling the stock they own 
+and buying long-term calls (LEAPS) as a substitute, or buying LEAPS instead of 
+making an initial purchase in a particular common stock. 
+Substitution for Stock Currently Held Long. Simplistically, this strate­
+gy involves this line of thinking: If one owns stock and sells it, an investor could rein­
+vest a small portion of the proceeds in a call option, thereby providing continued 
+upside profit potential if the stock rises in price, and invest the rest in a bank to earn 
+interest. The interest earned would act as a substitute for the dividend, if any, to 
+which the investor is no longer entitled. Moreover, he has less downside risk: If the 
+stock should fall dramatically, his loss is limited to the initial cost of the call. 
+In actual practice, one should carefully calculate what he is getting and what he 
+is giving up. For example, is the loss of the dividend too great to be compensated for 
+by the investment of the excess proceeds? How much of the potential gain will be 
+wasted in the form of time value premium paid for the call? The costs to the stock 
+owner who decides to switch into call options as a substitute are commissions, the 
+time value premium of the call, and the loss of dividends. The benefits are the inter­
+est that can be earned from freeing up a substantial portion of his funds, plus the fact 
+that there is less downside risk in owning the call than in owning the stock. 
+Example: XYZ is selling at 50. There are one-year LEAPS with a striking price of 40 
+that sell for $12. XYZ pays an annual dividend of $0.50 and short-term interest rates 
+are 5%. What are the economics that an owner of 100 XYZ common stock must cal­
+culate in order to determine whether it is viable to sell his stock and buy the one-year 
+LEAPS as a substitute? 
+The call has time value premium of 2 points (40 + 12 - 50). Moreover, if the 
+stock is sold and the LEAPS purchased, a credit of $3,800 less commissions would 
+be generated. First, calculate the net credit generated: 
+Credit balance generated: 
+Sale of 1 00 XYZ stock 
+Less stock commission 
+Net sale proceeds: 
+Cost of one LEAPS call 
+Plus option commission 
+Net cost of call: 
+Total credit balance: 
+$5,000 
+25 
+$4,975 credit 
+$3,760 credit 
+$1,200 
+15 
+$1,215 debit 
+Now the costs and benefits of making the switch can be computed: