378 Part Ill: Put Option Strategies 
stock owner would have been. If the company declared a stock dividend, it would 
have no effect on this strategy since the call owner is entitled to those. A change in 
interest rates is not a factor either, since the owner of the LEAPS should invest in a 
1-year Treasury bill or a 1-year CD and therefore would not be subject to interim 
changes in short-term interest rates. 
There may be other mitigating circumstances. Mostly these would involve tax 
considerations. If the stock is currently a profitable investment, the sale would gen­
erate a capital gain, and taxes might be owed. If the stock is currently being held at 
a loss, the purchase of the call would constitute a wash sale and the loss could not be 
taken at this time. (See Chapter 41 on taxes for a broader discussion of the wash sale 
rule and option trading.) 
In tl1eory, the calculations above could produce an overall credit, in which case the 
stockholder W(?uld normally want to substitute with the call, unless he has overriding tax 
considerations or suspects that a cash dividend increase is going to be announced. Be 
very careful about switching if this situation should arise. Normally, arbitrageurs - per­
sons trading for exchange members and paying no commission - would take advantage 
of such a situation before the general public could. If they are letting the opportunity 
pass by, there must be a reason (probably the cash dividend), so be extremely certain of 
your economics and research before venturing into such a situation. 
In summary, holders of common stock on which there exist in-the-money 
LEAPS should evaluate the economics of substituting the LEAPS call for the com­
mon stock. Even if arithmetic calculations call for the substitution, the stockholder 
should consider his tax situation as well as his outlook for the cash dividends to be 
paid by the common before making the switch. 
BUYING LEAPS AS THE INITIAL PURCHASE 
INSTEAD OF BUYING A COMMON STOCK 
Logic similar to that used earlier to determine whether a stockholder might want to 
substitute a LEAPS call for his stock can be used by a prospective purchaser of com­
mon stock. In other words, this investor does not already own the common. He is 
going to buy it. This prospective purchaser might want to buy a LEAPS call and put 
the rest of the money he had planned to use in the bank, instead of actually buying 
the stock itself. 
His costs - real and opportunity - are calculated in a similar manner to those 
expressed earlier. The only real difference is that he has to spend the stock commis­
sion in this case, whereas he did not in the previous example (since he already owned 
the stock).