402 Part Ill: Put Option Strategies 
is not the simple discount arbitrage that was discussed in Chapter l when this topic 
was covered. Rather, it is a more complicated form that is discussed in greater detail 
in Chapter 28. Suffice it to say that if the dividend is larger than the interest that can 
be earned from a credit balance equal to the striking price, then the time value pre­
mium will disappear from the call. 
Example: XYZ is a $30 stock and about to go ex-dividend 50 cents. The prevailing 
short-term interest rate is 5% and there are LEAPS with a striking price of 20. 
A 50-cent quarterly dividend on a striking price of 20 is an annual dividend rate 
(on the strike) of 10%. Since short-term rates are much lower than that, arbitrageurs 
economically cannot pay out 10% for dividends and earn 5% for their credit balances. 
In this situation, the LEAPS call would lose its time value premium and would 
be a candidate for early exercise when the stock goes ex-dividend. 
In actual practice, the situation is more complicated than this, because the price 
of the puts comes into play; but this example shows the general reasoning that the 
arbitrageur must go through. 
Certain arbitrageurs construct positions that allow them to earn interest on a 
credit balance equal to the striking price of the call. This position involves being short 
the underlying stock and being long the call. Thus, when the stock goes ex-dividend, 
the arbitrageur will owe the dividend. If, however, the amount of the dividend is 
more than he vvill earn in interest from his credit balance, he will merely exercise his 
call to cover his short stock. This action will prevent him from having to pay out the 
dividend. 
The arbitrageur's exercise of the call means that someone is going to be 
assigned. If you are a writer of the call, it could be you. It is not important to under­
stand the arbitrage completely; its effect will be reflected in the marketplace in the 
form of a call trading at parity or a discount. Thus, even a LEAPS call with a sub­
stantial anwunt of time rernaining may be assigned if it is trading at parity. 
STRADDLE SELLING 
Straddle selling is equivalent to ratio writing and is a strategy whereby one attempts 
to sell ( overpriced) options in order to produce a range of stock prices within which 
the option seller can profit. The strategy often involves follow-up action as the stock 
moves around, and the strategist feels that he must adjust his position in order to pre­
vent large losses. LEAPS puts and calls might be used for this strategy. However, 
their long-term nature is often not conducive to the aims of straddle selling. 
First, consider the effect of time decay. One might normally sell a three-month 
straddle. If the stock "behaves" and is relatively unchanged after two months have