374 Part Ill: Put Option Strategies 
Second, the figures depict the change in rates or dividends as being instantaneous. 
This is not completely realistic. If rates change, they will change by a little bit at a time, 
usually¼% or ½% at a time, perhaps as much as 1 %. If dividends are increased, that 
increase may be instantaneous, but it will not likely occur immediately after the 
LEAPS are purchased or sold. However, the point that these figures are meant to con­
vey is that interest rates and dividends have a much greater effect on LEAPS than on 
ordinary shorter-term equity options, and that is certainly a true statement. 
COMPARING LEAPS AND SHORT-TERM OPTIONS 
Table 25-1 will help to illustrate the problem in valuing LEAPS, either mentally or 
with a model. All of the variables - stock price, volatility, interest rates, and dividends 
- are given in increments and the comparison is shown between 3-month equity 
options and 2-year LEAPS. There are three sets of comparisons: for options 20% out­
of-the-money, options at-the-money, and options 20% in-the-money. 
A few words are needed here to explain how volatility is shown in this table. 
Volatility is normally expressed as a percent. The volatility of the stock market is 
about 15%. The table shows what would happen if volatility changed by one per­
centage point, to 16%, for example. Of course, the table also shows what would hap­
pen if the other factors changed by a small amount. 
Most of the discrepancies between the 3-month and the 2-year options are 
large. For example, if volatility increases by one percentage point, the 3-month out­
of-the-money call will increase in price by only 3 cents (0.03 in the left-hand column) 
while the 2-year LEAPS call will increase by 43 cents. As another example, look at 
the bottom right-hand pair of numbers, which show the effect of a dividend increase 
on the options that are 20% in-the-money. The assumption is that the dividend will 
increase 25 cents this quarter ( and will be 25 cents higher every quarter thereafter). 
This translates into a loss of 14 cents for the 3-month call, since there is only one ex­
dividend period that affects this call; but it translates into a loss of 1 ½ for the 2-year 
LEAPS, since the stock will go ex-dividend by an extra $2 over the life of that call. 
TABLE 25-1. 
Comparing LEAPS and Short-Term Calls. 
Change in Price of the Options 
20% out al 20% in 
Variable Increment 3-mo. 2-yr. 3-mo. 2-yr. 3-mo. 2-yr. 
Stock Pre. + 1 pt .03 .41 .54 .70 .97 .89 
Volatility + 1% .03 .43 .21 .48 .04 .33 
Int. Rate + 1/2% .01 .27 .08 .55 .14 .72 
Dividend + $.25/qtr 0 -.62 -.08 - l.18 -.14 -1.50