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Strategies & Market Trends : The Covered Calls for Dummies Thread
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To: Uncle Frank who wrote (3273)1/17/2002 6:16:50 PM
From: Dan Duchardt  Read Replies (1) of 5205
 
Uncle Frank,

You observation about the higher potential of losing all your money on a LEAPS call as compared to owning the stock is absolutely correct. However, in making a comparison of the calendar (same strike different month) or diagonal (different strike and different month) spreads to a conventional CC, the percentage loss is not always the significant factor. It depends on what you do with the money you "saved" buying a LEAPS instead of the underlying stock. If you put that money at risk, buying LEAPS to control more shares that you could afford to buy, that is playing with fire. But if you only buy LEAPS to control the shares you can afford, and put the rest of that money in a safe place (fixed interest investments of some sort), then the LEAPS affords greater protection to the downside. Losing $0.80 per share is always preferable to losing $1.00 per share if you are talking about the same number of shares. And the nice thing about the LEAPS is that for the second dollar drop, and the third, and so on, the ratio improves.

There is a tendency to think of going DITM for these long LEAPS in this strategy to minimize the time premium paid. IMHO opinion, that is a bad idea because it negates much of the benefit of buying the LEAPS. Moderately ITM LEAPS are much cheaper and can still be chosen to assure a profit if the stock goes up, with the added benefit that you can afford to roll down the LEAPS to a lower strike later on if the stock falls at a lower cost than buying the low strike LEAPS to start out.

Dan
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