Over the last several months, I’ve shown you several different options strategies that you can use to make serious money in the markets – simple call and put buys, bullish and bearish “Loophole Trades,” Straddles, and more.
But the constant in each of the strategies is that they have all been relatively short-term trade set ups designed to work within 20-30 days, with options that expire in about 45 days.
The mindset has been get in, get out and turn your profits pretty quickly – typically, the more efficiently you can use your capital, the better.
But I recognize that a lot of you come from a longer-term, buy-and-hold background. And I understand that this shorter-term, options-based way of generating income can be a bit much to take in as quickly as one would like.
So today, I’m going to show you a long-term options strategy you can use to boost your portfolio…
LEAPS is an acronym for Long-term Equity AnticiPation Securities (the P is often capitalized when it is written out to represent the P LEAPS to get the acronym to work).
These are options that allow for a longer time frame until expiration; you can buy many LEAPS as far out as two years and eight months before expiration.
They were created around 1990 and started out as only being available on stocks, but eventually became available on indexes and nowadays you can even find these on Exchange-Traded Funds (ETFs).
These are most often written, (but not exclusively) for January of whichever year up to two years out. Right now, in October 2015, you can buy LEAPS on underlying securities for October and November, whichever month comes next in that issue’s option expiration cycle, as well as and January 2016, 2017 and maybe even 2018. The January 2017 and 2018 would be considered LEAPS.
LEAPS options are in truth no different than their shorter-term siblings in that they have an expiration date, they can be found for both calls and puts, and they can be exercised at a given strike price.
But they come with some pretty terrific benefits…
The Benefits of Trading LEAPS
The primary benefit of LEAPS from an investment standpoint is they allow options traders the opportunity to take part in an underlying’s ability to make prolonged price moves without having to trade in and out of shorter-term option positions (racking up lots of brokerage fees in the process). One doesn’t have to stay quite as busy trading options like this.
LEAPS also allow for the opportunity to take advantage of the fact options are a way to leverage one’s cost in the trade. Since cost is risk, subsequently one’s risk is minimized over a straight stock purchase.
Take a look at the chart below on Nike Inc.(NYSE:NKE)
When buying LEAPS, I typically like to consider doing so on an underlying that shows a habit of sustaining substantial price moves over sustained periods of time. NKE fits that bill, showing a nice year-to-date uptrend.
Trading LEAPS vs. Trading the Underlying
To purchase 1,000 shares of NKE back in January 2015, (using the chart above, let’s consider the stock purchase price of $95), that would cost the investor $95,000 not including fees and commission. At the same time, buying the January 2016 $95 Calls, (10 contracts giving the owner the right to control 1,000 shares) would cost the options LEAPS trader $8,350 (the ask price on the $95 calls).
That is a SIGNIFICANTLY lower cost – and risk – than the outright purchase of the stock.
In fact, $8,350 is about a 91% reduction in cost/risk.
How’s that for leverage?
Another benefit is the Theta or Time Decay is MUCH less dramatic for a large part of its existence. A LEAPS option by its very nature isn’t going to have an expiration date right around the corner that the stock has to make a quick move in order to counter that time decay.
Let’s go back and take a look at NKE in January 2015. If you wanted to buy short-term options the Theta would be quite large.
Take a look at the Theta for the NKE February 2015 $95 Call in the chart below:
Now, take a lookJan16 95 Call:
As you can see, the Theta on the February expiration is almost three times greater than the Theta for the LEAPS.
Not only does one have more time for the stock to make a move, time decay isn’t as much a detriment to the position as the shorter-term expiration.
A Better Return on Investment
The Benefits of LEAPS:
LEAPS give you a way to participate in prolonged price moves on the underlying at a reduced cost and lower risk.
Theta or Time Decay is less dramatic, meaning the option will not lose value as fast a shorter-term option will.
A better ROI, meaning more bang for your buck, which is usually the case with any option trade when it works.
Options offer less cost and less risk, but when they work the Return on Investment (ROI) is better. You may make more money on the trade of the underlying, but from a pure return percentage on your money the option trade is usually better. Case in point look at the values of NKE stock today versus its LEAPS counterpart.
NKE stock is at $132. So if you bought back in January and want to sell the stock now, that would be a 37-point gain on the 1,000, a $37,000 profit. The ROI on that would be close to 39%. That is a very nice gain, and I bet many a money manager would love to have that type of return.
But take a look at the image below showing the options scenario and you will see a much better ROI number is/was available.
A whopping 329% ROI! Again, the money available to be made on the option trade is less than that on the stock scenario. But on a dollar for dollar basis, a return on your money basis, the options clearly outperformed the stock by leaps and bounds, if you’ll pardon my pun!
Pay Attention to Your Trade
Just like any option, they have an expiration date – so you’ll still have to keep an eye on your trade and manage it actively. You just won’t be up against the clock like you would be in a shorter-term option trade.
DeltaDelta is one of the options “Greeks” we’ve talked about before – one of four measurements of risk we use when trading options. An option’s delta tells us just how much exposure it has to shifts in the price of the underlying.For call options, delta values range from 0 to 1.0, while for put options they range from 0 to -1.0. So a long call option with a delta of 0.5, a one-point move in the underlying would produce a 0.50 change in the price of the call option.
Another thing that some may consider a drawback is the Delta isn’t going to be as large as a shorter term in-the-money option. The further out options expiration will have less of a delta move because there is so much more time left on them. Shorter-term options have a bigger dollar-for-dollar move capability than the LEAP.
One last thing to note: you definitely do notwant to use short-term tools such as Money Calendar or Darknet to find good underlying stocks for LEAPS trades. Those tools are designed to find trade ideas on underlying securities poised to make a calculated move within 20-30 days.
LEAPS are a great way to participate in options trading, giving yourself a means to participate in prolonged price moves in a variety of securities at a reduced cost, thereby limiting risk. They allow the leverage of options while also giving you a big of the buy-and-hold mindset you may be used to.
Here’s Your Trading Lesson Summary:
LEAPS – short for Long-term Equity AnticiPation Securities – are options that don’t expire for several months (or even years). Here’s what you need to know to trade LEAPS:
Options are usually available for the current month, the next month, as well as whichever month comes next in that issue’s option expiration cycle. LEAPS typically expire in January a year or two from the current month.
The long-term nature of LEAPS gives owners the advantage of long-term price moves – almost like owning the stock, but much, much cheaper (and with lower risk).
Keep in mind that LEAPS are still a fixed-time instrument with an expiration date. Additionally, the Delta – a measure of an option’s exposure to price swings in the underlying – isn’t as valuable as with shorter-term options.
Options are excellent tools for both position trading and risk management, but finding the right strategy is key to using these tools to your advantage. Beginners have several options when choosing a strategy, but first you should understand what options are and how they work. An option gives its holder the right, but not the obligation, to buy or sell the underlying asset at a specified price on or before its expiration date. There are two types of options: a call, which gives the holder the right to buy the option, and a put, which gives its holder the right to sell the option. A call is in-the-money when its strike price (the price at which a contract can be exercised) is less than the underlying price, at-the-money when the strike price equals the price of the underlying and out-of-the-money when the strike price is greater than the underlying. The reverse is true for puts. When you buy an option, your level of loss is limited to the option’s price, or premium. When you sell a na...
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