LEAPS – An Introduction to Long Term Options

LEAPS, or Long-term Equity AnticiPation Securities, are essentially the same as regular options, except that their expiration date is much further in the future.

Features of LEAPS include:

  • First became available in 1990
  • Longer term expiration dates (9 to 30 months away)
  • Due date is always in January
  • LEAPS have a different trading symbol naming procedure than regular options
  • Converts to regular option once it reaches within nine months of expiration, although the only real change is that the trading symbol changes to match the normal option naming procedure for symbol trading
  • Never more than two active LEAPS expiration cycles at a time (e.g. Jan 2009 and Jan 2010, but only Jan 2011 after Jan 2009 converts to regular option)
  • LEAPS are not available for every stock that trades options

Time Lapse and LEAPS

The amount of daily time decay, known as theta, occurs much more slowly with LEAPS than with short-term options. In fact, a fundamental characteristic of all options is that the closer an option gets to expiration, the faster the speed of the daily passage of time accelerates.

Benefits of LEAPS:

  • Ability to leverage position/investment without using margin
  • More time for the underlying stock to move in the direction you expect
  • Flexibility – LEAPS can be used on its own or as part of various other trading strategies

Disadvantages of LEAPS:

  • Bid-ask spread penalty is much higher for LEAPS than for short term options
  • Stocks MUST move (up for LEAP calls, down for LEAP puts) by a certain amount so you can break even when holding it as a simple long position
  • No benefit of ownership (dividends, voting rights, etc.)

What you can do with LEAPS:

In addition to simply buying and holding LEAPS as part of a medium to long-term replacement for owning the underlying stock (and potentially generating a much higher return), LEAPS can also be used as part of other strategies. Usually they are used in a covered call fashion where the LEAPS are held as a substitute for owning the underlying stock and then short term options (calls in this case), sold against them for income, or as a way to reduce the cost base on the LEAPS.

Conclusion:

Options strategies are many and varied. Strategies can be used to achieve any number of objectives. LEAPS is just another tool available to the flexible options trader. Like all options trading strategies, LEAPS can be used as conservatively or as aggressively as desired. If you are not familiar with LEAPS, further research may be warranted to determine if there should be a place for them in your own portfolio.