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Long-term Equity Anticipation Securities (LEAPS) are a type of stock or index option with notably longer expiration dates as compared to standard options. While most traditional options expire within a year, LEAPS options can have expirations that extend up to two or three years from the time they're issued.
Technically speaking, there aren't any further differences between LEAPS and other standard, exchange-listed stock and index options contracts.
Investors use LEAPS for various reasons, such as hedging long-term holdings, speculating on extended price movements, or generating income through strategies like covered calls. Due to their extended duration, LEAPS typically possess a higher premium than shorter-term options and experience slower time decay in their early days, which accelerates as they approach expiration.
Aside from having longer expiration dates, LEAPS are identical to other stock and index options. The information below helps illustrate how LEAPS work.
LEAPS Calls: Give the holder the right, but not the obligation, to buy the underlying security at a specified strike price up until the expiration date.
LEAPS Puts: Give the holder the right, but not the obligation, to sell the underlying security at a specified strike price up until the expiration date.
When you buy a LEAPS option, you pay a premium. This premium is generally higher than that of shorter-term options because of the extended time value associated with the extended expiration date.
Just like with standard options, when you purchase a LEAP option, you choose a strike price, which is the price at which the option can be exercised.
Like other options, LEAPS are exercised if they are in-the-money (ITM) at expiration.
A call LEAP (where the underlying security's current market price is higher than the strike price) can be exercised to purchase the underlying security at the strike price.
A put LEAP (where the underlying security's current market price is lower than the strike price) can be exercised to sell the underlying security at the strike price.
One of the primary factors influencing an option's price is time decay. The value of a LEAPS option erodes over time, but this erosion (or theta) is slower in the early days and accelerates as the option approaches its expiration date.
At times, LEAPS options may not be as liquid as their shorter-term counterparts. Bid-ask spreads may also be wider. It's essential to be aware of these dynamics when entering or exiting LEAPS positions.
Like regular monthly options, LEAPS can serve a variety of investment strategies.
Hedging: An investor holding a stock long-term might buy a put LEAP to protect against a significant drop in the stock's price.
Speculation: An investor bullish on a stock's long-term prospects might buy a call LEAP, anticipating a rise in the stock price over the next few years.
Rolling: Some investors use a strategy called rolling with LEAPs. As their LEAP nears expiration, they'll sell it and use the proceeds to buy another LEAP with a later expiration date, effectively extending the position.
While LEAPS function similarly to standard options, they offer more time for the position to play out, albeit at a higher initial cost (purchased options) or for a higher net credit (sold options).
LEAPS can last up to two or three years from the time they are issued. However, it's essential to note that while LEAPS start with longer durations, as time progresses and they approach their expiration dates, they behave more like standard short-term options, especially in terms of accelerating time decay.
LEAPS options, like other types of stock and index options, can be exercised at any time before or on their expiration date, provided they are American-style options. Most stock options traded in the United States - including LEAPS - are American-style, which means they can be exercised anytime before they expire.
On the other hand, European-style options can only be exercised at expiration. It's essential to be familiar with the terms of the specific LEAPS option contract you're dealing with to know its exercise characteristics.
While most traditional options expire within a year, LEAPS options can have expirations that extend up to two or three years from the time they're issued.
Technically speaking, there aren't any further differences between LEAPS and other standard, exchange-listed stock and index options contracts. Like other options, LEAPS are exercised if they are in-the-money (ITM) at expiration.
Therefore, a call LEAP option (where the underlying security's current market price is higher than the strike price) can be exercised to purchase the underlying security at the strike price.
An investor has been researching the renewable energy sector, and is confident that the green energy sector will expand in the coming years, and decides to invest in stock XYZ, which is a major player in the industry. Instead of buying the stock, the investor elects to purchase one call option.
Current Date: October 14, 2023
XYZ Stock Price: $50/share
Strike Price: $60
Expiration Date: October 14, 2025 (2 years from now)
Premium for One Option Contract: $8 (remember, one contract typically represents 100 shares, so the total cost would be $800).
By October 14, 2025, XYZ’s stock price has soared to $90 and the LEAPS call option allows you to buy 100 shares at only $60/share, even though they're now valued at $90/share in the market.
Profit from exercising the option = ($90 - $60) x 100 = $3,000
Net profit after accounting for the premium = $3,000 - $800 = $2,200
Stock XYZ rises to $69 by the expiration date. The option is still in-the-money, but the profit isn't as significant.
Profit from exercising the option = ($69 - $60) x 100 = $900
Net profit after accounting for the premium = $900 - $800 = $100
XYZ remains at $55/share, or falls below the strike price by the expiration date. In this scenario, it's not worth exercising your option since you can buy the stock cheaper in the market. The LEAPS call option expires worthless, and the investor loses the premium paid, which is $800.
While most traditional options expire within a year, LEAPS options can have expirations that extend up to two or three years from the time they're issued.
Technically speaking, there aren't any further differences between LEAPS and other standard, exchange-listed stock and index options contracts. Like other options, LEAPS are exercised if they are in-the-money (ITM) at expiration.
Therefore, a put LEAP option (where the underlying security's current market price is lower than the strike price) can be exercised to sell the underlying security at the strike price.
After researching stock DEF, an investor believes the company will face challenges in the coming years, and that its stock price will suffer. Instead of short-selling the stock, the investor decides to buy a LEAPS put option, which offers a way to profit from a potential decline with limited capital outlay.
Current Date: October 14, 2023
DEF Stock Price: $50/share
Strike Price: $45
Expiration Date: October 14, 2025 (2 years from now)
Premium for One Option Contract: $5 (one contract typically represents 100 shares, so the total cost would be $500).
By October 14, 2025, DEF’s stock price has declined to $30/share, which means the LEAPS put option allows the investor to sell 100 shares at $45/share, even though they're now only worth $30/share in the market.
Profit from exercising the option = ($45 - $30) x 100 = $1,500
Net profit after accounting for the premium = $1,500 - $500 = $1,000
The stock price of DEF drops to $39/share by the expiration date. While the stock has decreased in value, the profit from the put option is more limited, and does not outweigh the premium outlaid to enter the position.
Profit from exercising the option = ($45 - $39) x 100 = $600.
Net profit after accounting for the premium = $600 - $500 = $100.
The stock price rises to $60 or stays above the strike price of $45 through expiration. In this scenario, it's not advantageous to exercise your put option since selling in the open market would fetch a higher price. The LEAPS put option expires worthless, and the investor loses the premium paid, which is $500.
The suitability of a LEAPS option depends heavily on the outlook of the investor/trader, his/her specific trading approach, and his/her risk profile.
Listed below are some of the considerations investors and traders can use when considering LEAPS options positions.
Extended Timeframe: With expiration dates up to two or three years in the future, LEAPS provide market participants with a longer time horizon for their positions to play out.
Leverage: Like all options, LEAPS allow investors to control a larger amount of the underlying asset with a relatively small capital outlay.
Limited Risk: The maximum amount an investor can lose when purchasing a LEAP option is the premium paid, which can be considerably less than buying the underlying asset outright.
Flexibility: LEAPS can be used for a variety of purposes, including hedging long-term holdings, diversifying a portfolio, or speculating on long-term price movements without the need to invest in the asset directly.
Slow Initial Time Decay: In the early stages of a LEAP'S lifespan, the time decay (theta) is generally slower than that of a short-term option. That means the extrinsic value diminishes at a slower pace, initially.
Potential for Lower Implied Volatility: In some cases, longer-term options exhibit lower implied volatility than short-term options, leading to potentially cheaper premiums relative to the amount of time associated until expiration.
Higher Premiums: While they offer a longer timeframe, LEAPS usually come with higher premiums than shorter-term options because of the added time value.
Reduced Liquidity: LEAPS can be less liquid than standard options, which might result in wider bid-ask spreads. This can increase the cost of entering and exiting positions.
Exposure to Time Decay: As the expiration date approaches, the time decay of a LEAPS will accelerate, eroding its extrinsic value more quickly.
Dividend and Voting Rights: Holding a LEAP option doesn't grant the holder rights to dividends or voting rights in the company. Only by exercising a LEAPS call and purchasing the underlying shares can one access these benefits.
Complexity: For novice investors, understanding and managing long-term options can be complex. Factors like changes in implied volatility or interest rates can affect the value of these options more significantly.
Potential Underperformance: If the underlying asset doesn't move as anticipated, or if it moves very slowly in the desired direction, a LEAPS option may underperform as compared to a direct investment in the underlying asset.
Buying a LEAPS option is similar to purchasing any other type of option. To do so, investors and traders can follow these general guidelines.
Educate Yourself
As with all forms of investing, ongoing education is crucial. Consider using educational resources, tools, and simulated trading platforms offered by many brokers to improve your knowledge.
Always remember that options trading carries risks. Ensure you understand these risks, costs, and potential benefits before diving in. If needed, consult with a professional or take some online courses to bolster your understanding.
Research & Analysis
Start with thorough research to identify stocks or ETFs you believe will experience significant price movement over a longer term.
Decide if you want a LEAPS call (bullish outlook) or a LEAPS put (bearish outlook).
Open a Brokerage Account
If you don’t already have a brokerage account, you'll need to open one.
Ensure that the broker supports LEAPS options trading and has a robust platform for it.
Get Approval for Options Trading
Before trading options, including LEAPS, brokers typically require clients to get approval. This process involves answering questions about your trading experience, knowledge, and financial situation.
Brokers classify options trading levels based on their complexity. Ensure you're approved for the type of trades you intend to make.
Search for Your Desired LEAPS Option
On your broker's trading platform, search for the ticker of the stock or ETF you're interested in.
Look for the options chain, which lists all available option contracts.
Find the expiration date that's at least one year away to identify available LEAPS options.
Select Your LEAPS Option
Choose the strike price and contract type (call or put) based on your analysis and predictions.
Pay attention to the option's premium, open interest (number of open contracts), and volume (number of contracts traded in a day). High open interest often translates to increased liquidity.
Execute Your Order
Once you've selected the LEAPS option you want to purchase, initiate a "Buy to Open" order.
Determine the number of contracts you want to buy.
Choose an order type.
Monitor & Manage
After purchasing, monitor your LEAPS option regularly.
Stay updated with news and performance of the underlying asset, and consider any events that might impact its price.
Remember, you can close or exercise your LEAPS option before expiration if you want to lock in gains or minimize losses.
Consider Expiration Scenarios
If your option is in-the-money (ITM) as it nears expiration, you can either sell it to capture its value or exercise it.
If it's out-of-the-money and you believe it won't recover, you can let it expire worthless.
There's no set approach or strategy that market participants are required to utilize when trading LEAPS. However, there are several approaches that tend to garner significantly more volume in the marketplace.
For bullish traders, one popular approach is to use LEAPS as a stock replacement strategy. But LEAPS can also be utilized like other options—to generate income using a covered call, or to hedge a position/portfolio using a protective put. These three approaches are outlined below.
Using LEAPS as a Stock Replacement
Instead of buying a stock outright, you can purchase a deep in-the-money (ITM) LEAPS call option. This allows you to control the same number of shares for a fraction of the cost, providing leverage.
For example, instead of buying 100 shares of a company trading at $100/share for $10,000, you might buy a LEAPS call with a $70 strike price for a premium of $35 (or $3,500 for one contract representing 100 shares).
Instead of using shorter-term options, you can write covered calls using LEAPS calls. This involves owning the underlying stock and selling a LEAPS call option. This strategy can provide income via the premium and allows for long-term bullish positioning with some downside protection.
If you own a stock and are concerned about potential downside over the long term, you can purchase a LEAPS put option as insurance. If the stock drops significantly, the value of the LEAPS put option will likely rise, offsetting some or all of your losses.
Stocks and LEAPS are both financial instruments that give investors exposure to an underlying company, but they differ in several fundamental ways. Listed below are some high-level differences between the two
Ownership
Stocks: When you buy a stock, you become a partial owner of the company. You own a share of the company's assets and earnings.
LEAPS: Buying a LEAP option doesn't grant ownership in the company. Instead, you obtain the right to buy (call option) or sell (put option) the stock at a predetermined price up to a specific future date.
Dividends & Voting Rights
Stocks: Stockholders might receive dividends if the company distributes profits to its shareholders. They also typically have voting rights at shareholder meetings.
LEAPS: Options holders do not receive dividends and have no voting rights. However, if a LEAPS call option is exercised and the holder acquires the stock, they would then be entitled to dividends and voting rights.
Expiration
Stocks: Stocks do not expire. As long as the company is publicly traded, and doesn’t go bankrupt, you can hold onto your shares indefinitely.
LEAPS: Like all options, LEAPS have an expiration date. If they're not exercised by this date, they expire worthless.
Leverage
Stocks: Buying stocks requires paying the full price for each share, unless one uses margin.
LEAPs: Buying a LEAP option gives you leverage, meaning you can control a larger number of shares for a fraction of the cost of buying the shares outright. This can amplify both potential gains and losses.
Risk and Reward Profile
Stocks: The potential loss is limited to the amount invested, and the potential gain is theoretically unlimited.
LEAPS: The potential loss for the buyer is limited to the premium paid for the option. The potential gain for a call option is theoretically unlimited, while for a put option, the maximum gain occurs if the underlying stock goes to zero. The maximum loss for LEAPS options sellers is potentially unlimited.
Capital Requirement
Stocks: Requires a more substantial capital outlay, especially for high-priced shares.
LEAPS: Typically require less capital since you're only paying for the option premium, not the full share price.
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