Managing Your LEAPS

Hooper and Zalewski in their book Covered Calls and LEAPS a Wealth Option, detail the management techniques necessary to maintain high returns. While covered calls are intended to deliver returns in the area of 4% a month or 48% a year, LEAPS are designed to deliver returns in the range of high single digits to the lower teens. What this means is that one can potentially reach returns of 100% a year. A 50,000 dollar a year income can be replace with a $50,000 investment. Sound to good to be true? If something sounds too good to be true, then it is worth checking out.

The LEAPS Management Rules of Hooper and Zalewski

• The 10 Cent Rule
• The Delta Low Bridge Technique
• The 5% Buyback Rules

The 10 Cent Rule and Delta Low Bridge are applicable in a situation where the stock price has increased. If the bid price of the LEAPS increases to 10 cents above your cost in the LEAPS you buy back the short call at market price. You then add the cost of the buyback to your cost in the LEAPS and add 5%. If the LEAPS sells then you will have generated a return of 5% in a short period of time.

Under the Delta Low Bridge, you close out the entire transaction when you can realize a 5% return. The Delta is working in your favor because the construction of the LEAPS calls for a position with a delta of 1.90. When the stock price increases the LEAPS will increase at a much faster clip. When you close out using the Delta Low Bridge, you back the short call for a loss and then sell the LEAP in order to generate an overall profit. Thus, you must make sure to generate a minimum 5% return when you buy back the call and sell the LEAP.

For example, let's say you purchase a LEAPS for $10 and sell a call for a premium of $.90. The stock then goes up and thus the LEAP goes up to let's say a price of $12.00. For example sake, let's say the call has gone up to a $1.20. You can now buy the call back to close for a loss of $.30 and then sell the LEAPS for a gain of $2.00. $2.00 - .$30 = $1.70. $1.70/$10.00 = 17%.

You now have your money back and are ready to enter a new position following the rules.

In the case where the stock price drops, you can utilize the 5% Rule. Buy back the call for a net uncalled profit of 5% if market prices drop. You then add 5% to the cost of the LEAPS and put in a GTC order to sell at this price. If the LEAPS sells, you will have locked in a 10% return. To calculate the initial 5% return, you simply multiply your cost in the LEAPS by 5% and then subtract this number from the premium you received on the short call. This will be your call buyback price and you can enter a GTC order to automatically buy at this price. This will ensure that the call is bought back if the stock drops and allow you to not have to micro-monitor for this event.

Hooper and Zalewski provide a LEAPS screening tool at www.compoundstockearnings.com in the covered call toolbox. This screener includes a DLB index and ranks the positions lowest to highest according to percent increase for call out and is a very useful tool for this type of investing.