39 lines
3.0 KiB
Plaintext
39 lines
3.0 KiB
Plaintext
Chapter 25: LEAPS 401
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LEAPS calls may help to alleviate this problem. Since they are such long-term
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calls, they are likely to have some time value premium in them. In-the-money calls that
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have time value premium are not normally assigned. As an alternative to shorting a
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stock that is not borrowable, one might try to sell an in-the-money LEAPS call, but
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only if it has time value premium remaining. Just because the call has a long time
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remaining until expiration does not mean that it must have time value premium, as will
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be seen in the following discussion. Finally, if one does sell the LEAPS call, he must
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realize that if the stock drops, the LEAPS call will not follow it completely. As the stock
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nears the strike, the amount of time value premium will build up to an even greater
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level in the LEAPS. Still, the naked call seller would make some profit in that case, and
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it presents a better alternative than not being able to sell the stock short at all.
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Early Assignment. An American-style option is one that can be exercised at any
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time during its life. All listed equity options, LEAPS included, are of this variety.
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Thus, any in-the-money option that has been sold may become subject to early
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assignment. The clue to whether early assignment is imminent is whether there is
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time value premium in the option. If the option has no time value premium - in other
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words, it is trading at parity or at a discount then assignment may be close at hand.
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The option writer who does not want to be assigned would want to cover the option
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when it no longer carries time premium.
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LEAPS may be subject to early assignment as well. It is possible, albeit far less
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likely, that a long-term option would lose all of its time value premium and therefore
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be subject to early assignment. This would certainly happen if the underlying stock
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were being taken over and a tender off er were coming to fruition. However, it may
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also occur because of an impending dividend payment, or more specifically, because
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the stock is about to go ex-dividend. Recall that the call owner, LEAPS calls includ
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ed, is not entitled to any dividends paid by the underlying stock. So if the call owner
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wants the dividend, he exercises his call on the day before the stock goes ex-dividend.
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This makes him an owner of the common stock just in the nick of time to get the div
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idend.
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What economic factors motivate him to exercise the call? If there is any time
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value premium at all in the call, the call holder would be better off selling the call in
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the open market and then purchasing the stock in the open market as well. In this
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manner, he would still get the dividend, but he would get a better price for his call
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when he sold it. If, however, there is no time value premium in the call, he does not
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have to bother with two transactions in the open market; he merely exercises his call
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in order to buy stock.
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All well and good, but what makes the call sell at parity before expiration? It has
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to do with the arbitrage that is available for any call option. In this case, the arbitrage |