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High Leverage Diagonal
I am considering an Option strategy similar to a covered call except I would buy a LEAP instead of the stock?
i.e. Yahoo is trading at about $27 i would buy a LEAP JAN09 17.5 strike at $11.15 and sell/write a JAN08 30 strike for $1.15 total cost is $10 ($1000 for the contract), and as the calls I write expire I would write new ones for the next month until I get exercized (in the first trade that would be at $30 for a $250 profit on a $1000 investment) or offset the LEAP close to expiration, always making sure the strike price was high enough so that if excersized I would make money counting in the premiums I collected. Basically this is similar to standard covered calls but more leverage (I belive the proper term for this strategy would be a "Diagonal Spread"). Is there any downside of using LEAPS instead of Stock that I am missing besides the obvious time constraint where I have a little over a year to pull a profit as opposed to buying the stock where I have as long as it takes? Any suggestions or tips are appreciated.
What you are doing is using a LEAPS as an alternative for the stock in a covered call which is, in fact, a diagonal spread.
Here is what the CBOE has to say about using a LEAPS as an alternative to owning the stock:
http://www.cboe.com/Strategies/BEL-CallsAsStockAlternative.aspx
You are correct you are getting leverage by using the LEAPS instead of the stock, but you are also paying for that leverage. Since you are effectively paying $28.65 ($17.50 + $11.15) per share when the stock is trading for less than that amount, you should subtract the stock price from $28.65 to determine how much you are paying.
One common mistake that people make when considering a strategy like the one you mentioned is that they expect to get the same premium every time a call expires and they sell another. Just remember that when the Jan08 call expires you may not be able to get nearly as much for a March $30 call and maybe not even that amount for a lower strike price. A decrease in implied volatility (IV) and/or the stock price may make it much more difficult to make a profit that you expect.
I am not trying to talk you out of trying this strategy. It is a fairly common strategy that is not overly dangerous. I just want you to know that even if your first few trades do work out well, the strategy is not as easy as it may appear at first. Don't trade a lot of contracts at a time until you have had some go bad on you and you have figured out how to handle it when the do.
Aside from the sentence "This is nothing like a covered call." I pretty much agree with what Bob siad in the first reply.
One last point I'll add is that there is no such thing as a "LEAP" in the options world. "LEAPS" is an acronym and always includes the final "S" even if you are only talking about a single contract.
Channellock 337 Cutting Pliers