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: