m kearney - powerful techniques for options trading pdf
TRANSCRIPT
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Understanding StockOptions
Understanding StockOptions
LEAPS® for theExperienced Trader
Marty Kearney
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Disclosures
Options involve risks and are not suitable for everyone. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of standardized Options. Copies may be obtained by contacting your broker or the Options Industry Council at 440 S. LaSalle St., Chicago, IL 60605
In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in these materials. These costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Investors should consult their tax advisor about any potential tax consequences.
Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Past performance is not a guarantee of future results.
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Presentation Outline
• Brief review of basics• Why LEAPS®? Why bother?• Strategies
– Planning a stock purchase (or gift)– What stock traders should know– “Covered writing” with LEAPS®
– LEAPS® protective puts and collars– A year-end (LEAPS®) tax strategy
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LEAPS® - The Basics
• Long-term Equity AnticiPation Securities
• Expiration dates up to 2 1/2 years away(i.e., January 2004, January 2005)
• Different symbols / strikes
• Meaningful strikes, premiums
• All types of strategies
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LEAPS® - Rights & Obligations
CALLS PUTS
BUYERS RIGHT RIGHT(holders) to buy to sell
SELLERS OBLIGATION OBLIGATION(writers) to sell to buy
}
}
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LEAPS® Terms
• Strike price
• Premium
• Expiration
• Exercise/Assignment (European / American)
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LEAPS® - Ticker Symbols
Different root ticker symbols
– Wal Mart Stock symbol: WMTRegular Option symbol: WMTLEAPS Symbols: LWT ZWT
– Microsoft Stock symbol: MSFTRegular Option symbol: MSQLEAPS Symbols: LMF ZMF
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Options/LEAPS® Pricing
• Stock price• Strike price• Time to expiration• Interest rate / dividends• VolatilityUsing options requires
more decisions!
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LEAPS Time Decay
0
5
10
15
20
25
30
36 34 32 30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0
Time in Months
Pric
e
LEAPS®
Short-term option
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Why LEAPS®? Why Bother?
*$100 stock, 100-strike call, 30% vol, 5% interest rate, no divs.
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3-mo option 2-yr LEAP
Now: 3.40 11.00
1 month later: 2.75 10.70
2 months later: 1.90 10.40
3 months later: 0 10.10
LEAPS® Time Erosion
*stock unchanged @ $50 / 50 strike calls10
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WHY LEAPS®?
• Advantages• Lower cost “per unit of time”• Less time erosion• Longer life, more time for a strategy to
work• Disadvantages
• Higher absolute cost• Lower sensitivity to change in stock price
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LEAPS® Strategies
Using LEAPS® in a Gifting Program
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Using LEAPS® in a Gifting Program
• You plan to give $10,000 per year over the next 3 years to a relative.
• You want to buy approximately $30,000 of XYZ stock today.
• Is it possible to use LEAPS®
options to target these objectives?
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Using LEAPS® in a Gifting Program
• XYZ is currently trading at $39 per share
• The XYZ January 2005 LEAPS 30 Call is trading at $14.
• Step 1?• Step 2?• Step 3?
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Using LEAPS® in a Gifting Program
• Step 1 - Today
- Deposit $10,000 in recipient’s account
- Buy 7 XYZ January 2005 30 LEAPS® Calls at $14 each (Total Cost $9,800 + comm.)
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Using LEAPS® in a Gifting Program
• Step 2 – Next 3 Years
2003 (any month) – Deposit $10,000 inrecipient’s account
2004 (any month) – Deposit $10,000 inrecipient’s account
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Using LEAPS® in a Gifting Program
• Step 3 – XYZ above $30 in January 2005
-If still bullish on XYZ: exercise calls and purchase 700 XYZ at $30
-Total cost 700 x $30 = $21,000 + comm.($20,200 in recipient’s account)
-You can sell the calls if you wish. (Taxes?)
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Using LEAPS® in a Gifting Program
• Step 3 – XYZ below $30 in Jan 2005
- Calls expire for a total loss of cost of calls.
- There is still $20,200 in recipient’s account.
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Investing with LEAPS® - Variations
• Buy LEAPS® calls for yourself and save the purchase price of the stock over 2 years.
• Buy LEAPS® calls now and pay for the stock with a year-end bonus.
• Limit the risk of a stock purchase by buying LEAPS® calls and depositing the sufficient funds in a money market account. Risk is limited to the cost of the LEAPS® calls.
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LEAPS® Strategies
What Stock Traders Should Know
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Option Price Behavior
Stock Price: $50 è $51
Days to Exp: 90 è 90
50 Call: 3.00 è ?
What Stock Traders Should Know
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DELTA: Change in option price
for a one-point change in the
underlying stock price. If the
stock price changes by $1, then
the option price will change by
less than $1.
What Stock Traders Should Know
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What Stock Traders Should Know
• XYZ trading at $39• January 2004 LEAPS® 30 Calltrading at $13
• What is the delta of this call?If the stock rises from $39 to $45 in 60 days, what will the call price be?
23 * All examples do not include commissions and are not intended to be recommendations.
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What Stock Traders Should Know
• XYZ trading at $39• January 2004 LEAPS® 45 Calltrading at $7
• What is the delta of this call?If the stock rises from $39 to $45 in 60 days, what will the call price be?
24 * All examples do not include commissions and are not intended to be recommendations.
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What Stock Traders Should Know
• When trading LEAPS® know the delta.• Have three exit points in mind:
– Profit target– Time limit– Stop-loss point
• Have the discipline to exit the trade when any of the points is reached.
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Trading LEAPS® vs. Trading Stock
• LEAPS® Advantages– Lower Investment– Lower risk– Potentially higher percentage profit
• LEAPS® Disadvantages– Lower absolute profit– Potentially larger percentage loss– No dividends, voting rights
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LEAPS® Strategies
“Covered Writing” with LEAPS®
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“Covered Writing” with LEAPS®
• Using LEAPS® as a stock substitute to create a position similar to a covered write (known as a Time-Diagonal spread).
• Example: XYZ @ 49.00 on 8/1/02
Buy 1 XYZ Jan 2004 40 Call @ 14.00Sell 1 XYZ Sep 2002 55 Call @ 1.65
* Must be done in a margin account.* All examples do not include commissions and are not intended to be recommendations.
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“Covered Writing” with LEAPS® 1
At September ’02 Option Expiration
Stock Price: $49.00 (unchanged)
Sep ’02 55 Call: 1.65 è 0 +1.65
Jan ‘04 40 Call: 14.00 è ?
If S-T call expires, do it again(?)29
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“Covered Writing” with LEAPS® 2
At September ’02 Option Expiration
Stock Price: $59.00 (stock up big)
Sep ’02 55 Call: 1.65 è 4.00 -2.35
Jan ‘04 40 Call: 14.00 è ?
S-T call is I-T-M! Assigned?29
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“Covered Writing” with LEAPS® 3
At September ’02 Option Expiration
Stock Price: $39.00 (stock down big)
Sep ’02 55 Call: 1.65 è 0 +1.65
Jan ‘04 40 Call: 14.00 è ?
Stock price decline - stop-loss point?29
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“Covered Writing” with LEAPS®
• Potential profit*= $6.00 in 50 days (8/1–9/20)
• Initial Investment = 12.35 (14.00 – 1.65)• Percentage profit* = 48% in 50 days• Risk limited to initial investment + comm.• Risk of early assignment on short call
*Profit Potential and Percentage Profit are estimates only, assuming XYZ at $55 or higherMust be done in a margin account.All examples do not include commissions and are not intended to be recommendations.30
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“Covered Writing” with LEAPS®
Alternatives if short call is assigned:– Purchase stock and sell another S-T call– Purchase stock and stay long the LEAPS®
call– Close entire position by purchasing stock and selling LEAPS® call
– Close position by exercising LEAPS® call (not advised if there is time premium in the LEAPS® call)
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“Covered Writing” with LEAPS®
• What if the stock price declines significantly?– Will you sell the LEAPS® call at a loss?– Will you write another short-term call with a lower strike price?
– Will you keep the LEAPS® Call without selling another short-term call against it?
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LEAPS® Strategies
LEAPS® Married Puts
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LEAPS® Married Puts
Purchase LEAPS® puts when initially acquiring shares
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LEAPS® Married Puts
Purchase put options when initially acquiring shares
Example:
Stock @ _________________
Buy ____________________
* All examples do not include commissions and are not intended to be recommendations.
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Buy 100 shares ________ @ ________
Purchase one ____________ @ ________
Total investment per share _________
Put exercise price (strike price) _________
Total risk _________
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LEAPS® Married Puts
* All examples do not include commissions and are not intended to be recommendations.
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LEAPS® Married Puts
+
0
- Stock with Put
Stock
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LEAPS® Protective Put
• Already own shares
• Concerned about ? ? ? ?
• Don’t wish to sell shares now
• Tax considerations?
• Buy LEAPS® Puts as “term insurance”
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LEAPS® Puts - Pros & Cons
• Protection at a fixed cost• Flexibility: keep shares and dividends • Limited cost / limited risk
• Protection can be expensive• Increases overall cost/breakeven• Puts expire, stock does not• Periodic check is essential
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LEAPS® Strategies
The LEAPS® Collar
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The LEAPS® Collar
Collar defined:Long an O-O-M Put andshort an O-O-M Callin conjunction witha long stock position
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LEAPS® Collar for Protection
Long XYZ stock @75Action:
Buy 70 Put andSell 90 Call
* All examples do not include commissions and are not intended to be recommendations.
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Why Use a LEAPS® Collar ?
Collar all of (or part of)a large stock holdingwith LEAPS® when
“low-cost” protectionis desired
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LEAPS® Collar Case Study
You plan to retire in 2005.
You own $750,000 of XYZ.
You cannot afford to let the value fall below $600,000.
You want some upside.
You can’t afford to buy puts.
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LEAPS® Collar Case Study
Own ________ shares ________ at _________
Buy _________________ puts @ ________
Sell__________________ calls @ ________
Net cost per collar ________
Cost of Hedge ________________________
10,000 75.00XYZ
* All examples do not include commissions and are not intended to be recommendations.
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LEAPS® Collar Case Study
• Minimum value at Jan ’05?
• Maximum value at Jan ’05?
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Using a LEAPS® Collar 2
You want to buy stock.
You want to limit risk.
You want some upside.
You do not want to pay for insurance!
Collar a stock position with LEAPS®
when initially acquiring shares
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Using a LEAPS® Collar 2
Buy 100 shares of XYZ @ $ 75.00Buy 1 XYZ Jan ’05 70 LEAPS put 13.00Sell 1 XYZ Jan ’05 90 LEAPS call 11.60
Net Cost: $76.40Risk : $ 6.40 (8.5%)Potential Gain: $13.60 (17.8%)above example excludes transaction costs
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Using a LEAPS® Collar 2
+
0
- Stock with Collar
Stock
Call StrikePut Strike
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LEAPS® Collars - Pros & Cons
• Protection at a reduced cost• Favorable risk/reward ratio
• Limited upside• Limited time period• Risk of early assignment
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A Year-end (LEAPS®) Tax Strategy
You bought a stock and it went down in priceYou are thinking of selling it for a tax lossYou are aware of the 30 day before/after rule
(you cannot sell a security for a loss and buy it within 30 days before or after the date of sale)
You do not want to “Double up” with an additional 100 shares 31 days before
You do not want to be “out of the market” for 31 days
What can you do???
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Year-end (LEAPS®) Tax Strategy
Consider the
“ ”
LEAPS® Tax Strategy
Example: Bought 100 shares XYZ at $ 65Current Price: $ 35
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Year-end (LEAPS®) Tax Strategy
• November 25th - buy 1 XYZ Jan ’04 30 strike LEAPS® Call at $8.50
• December 27th – sell 100 shares of XYZ at $35
• Jan 31st - a choice –– Do nothing, control 100 shares with the long
LEAPS call for 12 months with limited risk– Buy 100 shares and sell the LEAPS® call, re-
establishing the original position
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Year-end (LEAPS®) Tax Strategy
• Advantages: – Realize loss on stock (tax implications?)– Still in the market with minimal outlay and
limited risk• Disadvantages:
– Commission intensive– Amount invested in LEAPS® as well as
amount invested in stock at risk for first 31 days
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SUMMARY
LEAPS®
� Wide range of possible uses
� Can be a strategic tool for risk management
� Can help combat one of the greatest enemies of options buyers: TIME EROSION
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Options Industry Council1-888-OPTIONS
Additional Web Sites:www.888options.comwww.amex.comwww.cboe.comwww.iseoptions.comwww.pacificex.comwww.phlx.com
PLEASE FILL OUT EVALUATION!
OICTHE OPTIONS
INDUSTRY COUNCIL
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Understanding StockOptions
Understanding StockOptions
ANSWERSLEAPS® for the
Experienced Trader
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LEAPS® - Ticker Symbols
Different root ticker symbols
– Wal Mart Stock symbol: WMTRegular Option symbol: WMTLEAPS Symbols: LWT ZWT
– Microsoft Stock symbol: MSFTRegular Option symbol: MSQLEAPS Symbols: LMF ZMF
’04 ‘05
’04 ‘05
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3-mo option 2-yr LEAP
Now: 3.40 11.00
1 month later: 2.75 10.70
2 months later: 1.90 10.40
3 months later: 0 10.10
LEAPS® Time Erosion
*stock unchanged @ $50 / 50 strike calls
(0.65) or 19 %
(0.85) or 30%
(1.90) or 100%
(0.30) or 3%
(0.30) or 3%
(0.30) or 3%
8 x 3.40 ≅ 27
10
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Option Price Behavior
Stock Price: $50 è $51
Days to Exp: 90 è 90
50 Call: 3.00 è ?
What Stock Traders Should Know
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3.50
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What Stock Traders Should Know
• XYZ trading at $39• January 2004 LEAPS® 30 Calltrading at $13
• What is the delta of this call?If the stock rises from $39 to $45 in 60 days, what will the call price be?
$13 è ?$17.30
Delta = .76
Profit +4.30 vs. +6.00Cost 13.00 vs. 39.00
23 * All examples do not include commissions and are not intended to be recommendations.
I-T-M Call
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What Stock Traders Should Know
• XYZ trading at $39• January 2004 LEAPS® 45 Calltrading at $7
• What is the delta of this call?If the stock rises from $39 to $45 in 60 days, what will the call price be?
$7 è ?$9.80
Delta = .52
Profit +2.80 vs. +6.00
Cost 7.00 vs. 39.0024 * All examples do not include commissions and are not intended to be recommendations.
O-O-M Call
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“Covered Writing” with LEAPS® 1
At September ’02 Option Expiration
Stock Price: $49.00 (unchanged)
Sep ’02 55 Call: 1.65 è 0 +1.65
Jan ‘04 40 Call: 14.00 è 13.50 - 0.50
Net Profit: +1.15 ?
If S-T call expires, do it again(?)29
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“Covered Writing” with LEAPS® 2
At September ’02 Option Expiration
Stock Price: $59.00 (stock up big)
Sep ’02 55 Call: 1.65 è 4.00 -2.35
Jan ‘04 40 Call: 14.00 è 21.75 +7.75
Net Profit: +5.40?
S-T call is I-T-M! Assigned?29
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“Covered Writing” with LEAPS® 3
At September ’02 Option Expiration
Stock Price: $39.00 (stock down big)
Sep ’02 55 Call: 1.65 è 0 +1.65
Jan ‘04 40 Call: 14.00 è 6.75 - 7.25
Net Loss: - 5.60?
Stock price decline - stop-loss point?29
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LEAPS® Married Puts
Purchase LEAPS® puts when initially acquiring shares
Limits risk during life of the put
Unlimited profit potential(less cost of puts)
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LEAPS® Married Puts
Purchase put options when initially acquiring shares
Example:
Stock @ _________________
Buy ____________________
HD @ 30.00 on 7/31/02
HD Jan ‘04 30 Put @ 5.25
* All examples do not include commissions and are not intended to be recommendations.
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Buy 100 shares ________ @ ________
Purchase one ____________ @ ________
Total investment per share _________
Put exercise price (strike price) _________
Total risk _________
36
LEAPS® Married Puts
HD 30.00
Jan ‘04 30 Put 5.25
35.25
30.00
5.2515% risk in 18 months
Profit potential unlimited* All examples do not include commissions and are not intended to be recommendations.
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LEAPS® Collar Case Study
Own ________ shares ________ at _________
Buy _________________ puts @ ________
Sell__________________ calls @ ________
Net cost per collar ________
Cost of Hedge ________________________
10,000 75.00XYZ
87 Jan ‘05 70
90 Jan ‘05 90
13.00
11.60
87 x $140 - $3480 = $8700
1.40
* All examples do not include commissions and are not intended to be recommendations.
Protecting only 8,700 shares.
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LEAPS® Collar Case Study
• Minimum value at Jan ’05?
• Maximum value at Jan ’05?Calls assigned – sell 9,000 XYZ @ $90
Plus value of other 1,300 shares
9,000 x $90 = $810,000 less comm.
Exercise puts – sell 8,700 XYZ @ $70
8,700 x $70 = $609,000 less comm.
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Using a LEAPS® Collar 2
Buy 100 shares of XYZ @ $ 75.00Buy 1 XYZ Jan ’05 70 LEAPS put 13.00Sell 1 XYZ Jan ’05 90 LEAPS call 11.60
Net Cost: $76.40Risk : $ 6.40 (8.5%)Potential Gain: $13.60 (17.8%)above example excludes transaction costs
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Year-end (LEAPS®) Tax Strategy
Consider the
“Thanksgiving - Christmas - Super Bowl”
LEAPS® Tax Strategy
Example: Bought 100 shares XYZ at $ 65Current Price: $ 35
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Year-end (LEAPS®) Tax Strategy
• November 25th - buy 1 XYZ Jan ’04 30 strike LEAPS® Call at $8.50 (Thanksgiving)
• December 27th – sell 100 shares of XYZ at $35 (Christmas)
• Jan 31st - a choice –– Do nothing, control 100 shares with the long
LEAPS call for 12 months with limited risk– Buy 100 shares and sell the LEAPS® call, re-
establishing the original position (Super Bowl)