Chapter 25: LEAPS 393 
The larger premium of the LEAPS call that was written produces this dramatically 
lower break-even price for the LEAPS covered write. 
Similar comparisons could be made for a covered write on margin if the investor 
is using a margin account. The steps above are the mechanical ones that a covered 
writer should go through in order to see how the short-term write compares to the 
longer-term LEAPS write. Analyzing them is often a less routine matter. It would 
seem that the short-term write is better if one uses the annualized rate of return. 
However, the annualized return is a somewhat subjective number that depends on 
several assumptions. 
The first assumption is that one will be able to generate an equivalent return six 
months from now when the July 50 call expires worthless or the stock is called away. 
If the stock were relatively unchanged, the covered writer would have to sell a 6-
month call for 4 points again six months from now. Or, if the stock were called away, 
he would have to invest in an equivalent situation elsewhere. Moreover, in order to 
reach the 2-year horizon offered by the LEAPS write, the 6-month return would 
have to be regenerated three more times (six months from now, one year from now, 
and a year and a half from now). The covered writer cannot assume that such returns 
can be repeated with any certainty every six months. 
The second assumption that was made when the annualized returns were cal­
culated was that one-half the return if exercised on the LEAPS call would be made 
when one year had passed. But, as has been demonstrated repeatedly in this chapter, 
the time decay of an option is not linear. Therefore, one year from now, if XYZ were 
still at 50, the January 50 LEAPS call would not be selling for half its current price 
(½ x 8½ = 4¼). It would be selling for something more like 5.00, if all other factors 
remained unchanged. However, given the variability of LEAPS call premiums when 
interest rates, volatility, or dividend payouts change, it is extremely difficult to esti­
mate the call price one year from now. Consequently, to say that the 21.5% 2-year 
return if exercised would be 10.8% after one year may well be a false statement. 
Thus, the covered writer must make his decision based on what he knows. He 
knows that with the short-term July 50 write, if the stock is called away in six months, 
he will make 6.9%, period. If he opts for the longer term, he will make 21.5% if he 
is called away in two years. Which is better? The question can only be answered by 
each covered writer individually. One's attitude toward long-term investing will be a 
major factor in making the decision. If he thinks XYZ has good prospects for the long 
term, and he feels conservative returns will be below 10% for the next couple of 
years, then he would probably choose the LEAPS write. However, if he feels that 
there is a temporary expansion of option premium in the short-term XYZ calls that 
should be exploited, and he would not really want to be a long-term holder of the 
stock, then he would choose the short-term covered write.