Understanding LEAPS

The option term LEAPS stands for: Long Term Equity AnticiPation Securities.

This may be a new term for beginners or an old term for most traders. If it’s a new term for you then this should be an educational blog for you. If it’s not new then still read on as this should provide some extra information that a lot of options traders don’t consider or use when they trade LEAPS. 

LEAPS are generally considered options that expire way out in the future; typically 9 months or more. Usually when you see them it will be the January or July options that are one to three years out. Having this extra time can provide patient, and long term option traders the ability to sit back and let the market do what we expect it to do. There are still Calls and Puts available for these types of options. They will act similar to regular options but may offer additional rewards and/or risk to your position. Don’t forget that because you’re buying further out in the future that you will pay more for the time, thus giving you a more expensive option trade.

I have heard the term that LEAPS are the “poor man’s stock� which I think is appropriate.  Because a lot of traders will buy these for the sole purpose of getting into the stock down the road from now as it rises well into the money it makes it an easy and profitable way for us to own the stock at a pre-determined price for cheaper than what it would have cost us to buy it after it has already risen in value. Here are a couple of examples that show us how LEAPS can be advantageous to traders.

MARCH 09 Calls

Strike    Symbol    Bid    Ask   Delta

JANUARY 2010 Calls

Assuming the day is the 9^th of January; the March 12.50 Strike Price @ 2.75 per share would expire on the 3^rd Friday of March which is about 70 days until expiration. That’s means if I do the math right that I am spending about 0.039 cents per share for the ability to control that option for the full 70 days. If the stock does nothing then that’s literally what it costs per day just to own that option.

Compare that to the January 2010 12.50 Strike price @ 5.40 per share. That would make these options expire in 371 days. That’s about 0.014 cents per share to own that option.

This shows that it’s far cheaper on a per share basis to buy longer term options.  Yet at the same time because you are spending more money that means you are giving yourself a bigger amount of loss that you could sustain if the stock does not reach the levels you want it to reach.

I show you this so that you can see that even though we buy further out it does give us a great advantage of having a lot of time for the stock to develop. It makes it possible to make much larger profits, and makes it possible to have more patience and calmness in our trades. Just something to consider as you look at the possibilities you have as options traders.

So it’s obvious that there are great advantages to LEAPS if there are big moves in the stock in the first quarter or half of the options life span. On the other hand if it does not make these strides then the loss or the disadvantages may prove to be more damaging than investors may be willing to suffer.

As with any other type of investment; I always recommend you do a lot of practice trading with LEAPS and compare your successes with regular options that you normally trade. See if it makes a good financial sense to you and if you want to have and utilize these in your portfolio.

Practice a lot, trade with a smile, and I wish you many successes in the year ahead.

Happy Trading!  – Josh Willis