Chapter 25: LEAPS 
Costs of switching: 
Time value premium 
Loss of dividend 
Stock commissions 
Option commissions 
Total cost: 
Fixed benefit from switching: 
Interest earned on 
credit balance of $3,760 
at 5% interest for one year= 0.05 x $3,760: 
Net cost of switching: 
317 
-$200 
-$ 50 
-$ 25 
- .l__Ll_ 
-$290 
+ $188 
- $102 
The stock owner must now decide if it is worth just over $1 per share in order 
to have his downside risk limited to a price of 39½ over the next year. The price of 
39½ as his downside risk is merely the amount of the net credit he received from 
doing the switch ($3,760) plus the interest earned ($188), expressed in per-share 
terms. That is, if XYZ falls dramatically over the next year and the LEAPS expires 
worthless, this investor will still have $3,948 in a bank account. That is equivalent to 
limiting his risk to about 39½ on the original 100 shares. 
If the investor decides to make the substitution, he should invest the proceeds 
from the sale in a 1-year CD or Treasury bill, for two reasons. First, he locks in the 
current rate - the one used in his calculations - for the year. Second, he is not tempt­
ed to use the money for something else, an action that might negate the potential 
benefits of the substitution. 
The above calculations all assume that the LEAPS call or the stock would have 
been held for the full year. If that is known not to be the case, the appropriate costs 
or benefits must be recalculated. 
Caveats. This ($102) seems like a reasonably small price to pay to make the switch 
from common stock to call ownership. However, if the investor were planning to sell 
the stock before it fell to 39½ in any case, he might not feel the need to pay for this 
protection. (Be aware, however, that he could accomplish essentially the same thing, 
since he can sell his LEAPS call whenever he wants to.) Moreover, when the year is 
up, he will have to pay another stock commission to repurchase his XYZ common if 
he still wants to own it ( or he will have to pay two option commissions to roll his long 
call out to a later expiration date). One other detriment that might exist, although a 
relatively unlikely one, is that the underlying common might declare an increased 
dividend or, even worse, a special cash dividend. The LEAPS call owner would not 
be entitled to that dividend increase in whatever form, while, obviously, the common