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Ask the Institute

DATE: April 3, 2002

QUESTION:
Will the Stock Repair Strategy work as well with LEAPS as with short-term options, since that would lower my commissions?

ANSWER:
The repair strategy is a combination of two strategies, the covered write and (using the proceeds from the call written) the purchase of a call vertical spread. Some investors use the selling of LEAPS calls to generate income. Most do not. Most investors sell shorter-term options. Options do not decay in a linear manner (a seven month option trading at $7, a four month option trading at $4, etc). Option price decay accelerates as expiration approaches. So if you sell a LEAPS call, yes you would pay less in commissions because you sold only once versus selling many times, but the two drawbacks are time decay is very slow and you have an obligation for a very long period of time. (For more information on the Stock Repair Strategy, please visit the CBOE website at: http://www.cboe.com/LearnCenter/RCStrategies.asp.)

An additional problem with a LEAPS Repair strategy is the second half of the trade. Vertical spreads are price dependent (the stock needs to do what we want it to do) and time dependent. An example: XYZ is at 45, and we do the 45 - 60 twenty month LEAPS repair strategy. Assume your break-even point after transaction costs is $59. Time dependent means that if XYZ rallies to $59 in three months, this position should still be out of the money. The vertical spread will widen as you approach $60 and as you approach expiration.

You may wish to "test drive" these positions by visiting CBOE.com and look for "The Options Toolbox" before initiating your strategy. You may find a LEAPS repair is better suited to your needs, or may find that doing this repair multiple times is (even after transaction costs) a better fit.

P.S. There is a new LEAPS book, Understanding LEAPS, due out in the second quarter of 2002. McGraw Hill is the publisher, and it was written by Marc Allaire and Marty Kearney, a consultant and instructor respectively at The Options Institute at the CBOE.


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