49 lines
2.4 KiB
Plaintext
49 lines
2.4 KiB
Plaintext
Chapter 25: LEAPS 391
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make from the LEAPS write with returns that can be made from repeatedly writing
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shorter-term calls. Of course, there is no guarantee that he will actually be able to
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repeat the short-term writes during the longer life of the LEAPS.
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As an aside, the strategist who is utilizing the incremental return concept of cov
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ered writing may find LEAPS call writing quite attractive. This is the strategy where
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in he has a higher target price at which he would be willing to sell his common stock,
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and he writes calls along the way to earn an incremental return (see Chapter 2 for
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details). Since this type of writer is only concerned with absolute levels of premiums
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being brought into the account and not with things like return if exercised, he should
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utilize LEAPS calls if available, since the premiums are the largest available.
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Moreover, if the incremental return writer is currently in a short-term call and is
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going to be called away, he might roll into a LEAPS call in order to retain his stock
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and take in more premium.
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The rest of this section discusses covered writing from the more normal view
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point of the investor who buys stock and sells a call against it in order to attain a par
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ticular return.
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Example: XYZ is selling at 50. The investor is considering a 500-share covered write
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and he is unsure whether to use the 6-month call or the 2-year LEAPS. The July 50
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call sells for 4 and has 6 months of life remaining; the January 50 LEAPS call sells for
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8½ and has 2 years of life. Further assume that XYZ pays a dividend of $0.25 per
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quarter.
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As was done in Chapter 2, the net required investment is calculated, then the
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return (if exercised) is computed, and finally the downside break-even point is deter
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mined.
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Stock cost (500 shares @ 50)
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Plus stock commission
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Less option premiums received
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Plus option commissions
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Net cash investment
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Net Investment Required
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July 50 call
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$25,000
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+ 300
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2,000
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+ 50
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$23,350
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January 50 LEAPS
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$25,000
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+ 300
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4,250
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+ 100
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$21,150
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Obviously, the LEAPS covered writer has a smaller cash investment, since he is sell
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ing a more expensive call in his covered write. Note that the option premium is being
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applied against the net investment in either case, as is the normal custom when doing
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covered writing.
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Now, using the net investment required, one can calculate the return (if exer
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cised). That return assumes the stock is above the striking price of the written option |