Jon,
I think people tend to look at covered call writing, whether covered by stock or a LEAP, from the wrong perspective.
I view covered call writing as business of selling a decaying asset, like ice cream on a hot day, in the anticipation of it expiring worthless. However, there is the possibility, however remote, <GGGGG> that I am wrong.
I buy the underlying asset, hopefully one that will not also decay, to protect myself from the deadly position of having the option suddenly skyrocket in value because of a change in the company news, weather, phase of the moon ...
A leap performs as an insurance policy as well as the underlying stock would, with one exception.
When you purchase the LEAP, you are paying for a significant amount of extrinsic (time) value. When the underlying suddenly moves up, the extrinsic value of the LEAP decays at a faster rate than the nearer term option. This is an additional source of loss. Taken, as an example to an extreme, if the stock price moves to near infinity, the extrinsic value goes to zero and the LEAP and the near term option have the same value. The premium you paid for a longer life has zero value.
A real example AMAT, stock at 82 1/4:
AMAT JAN00 90 is 7 1/4 by 7 1/2
AMAT JAN02 90 is 26 5/8 by 27 3/8
A 2 year premium of 19 3/8 to 19 7/8.
AMAT JAN00 40 is 41 1/8 by 42 1/8
AMAT JAN02 40 is 50 1/4 by 51
The 2 year premium has deflated to 10 1/4 to 8 7/8.
The further into the money the options go, the more money lost by the short term writer.
When you purchase the stock and sell against it, the stock has not extrinsic value and appreciates faster than the option sold, therefore there is no additional loss, no matter how high the stock rises. Of course, if it goes down...
That said, I do CC's against LEAPS routinely. But in this case, you must be ready to close the position if the stock starts a serious run, to avoid loosing all of the extrinsic value.
Ira |
