LEAPS options offer a unique way for investors to gain long-term exposure to stocks.
While the claim of buying stocks at a guaranteed 70% discount is an oversimplification,
LEAPS can be used strategically to potentially acquire shares at a lower cost basis.
This article explores how LEAPS options work and how to use them to your advantage.
Understanding LEAPS Options
LEAPS (Long-term Equity Anticipation Securities) are long-term options contracts with
expiration dates that are typically a year or more in the future. They offer investors
exposure to a stock’s price movement over an extended period.
Key Concepts
- Call Option: Gives the buyer the right, but not the obligation, to buy 100 shares of a stock at a specific price (strike price) before the expiration date.
- Put Option: Gives the buyer the right, but not the obligation, to sell 100 shares of a stock at a specific price (strike price) before the expiration date.
- In-the-Money (ITM): A call option is ITM when the stock price is above the strike price. A put option is ITM when the stock price is below the strike price.
- Out-of-the-Money (OTM): A call option is OTM when the stock price is below the strike price. A put option is OTM when the stock price is above the strike price.
The “70% Discount” Illusion
The idea of buying stocks at a 70% discount using LEAPS comes from buying deeply
in-the-money (ITM) call options.
Example:
- Stock Price: $100
- 1-Year LEAPS Call Option Strike Price: $30
- Option Premium: $72
In this case, the option costs $72 per share, and you have the right to buy the stock at $30. It might seem like you’re paying $102 for a $100 stock (strike price + premium), which is a discount compared to buying it outright.
However, this is an illusion. You’re paying the premium for the right to buy the stock at the strike price, not for the stock itself.
How to Use LEAPS Strategically
While the “70% discount” is misleading, LEAPS can be used strategically:
1. Long-Term Bullish Bets
Buy ITM LEAPS call options on stocks you believe will significantly increase in price over the long term. This can be a way to gain exposure with less capital outlay than buying the stock outright.
2. Capital Efficiency
LEAPS can be more capital-efficient than buying the stock, freeing up funds for other investments.
3. Leverage (Use with Caution)
LEAPS provide leverage, meaning your percentage gains can be magnified, but so can your losses.
4. Income Generation (Covered Calls)
After acquiring shares through LEAPS, you can sell shorter-term call options against them to generate income (covered call strategy).
Risks of LEAPS Options
- Time Decay: Options lose value over time, especially as expiration approaches.
- Volatility: Options prices are sensitive to changes in volatility.
- Limited Upside: Your profit is limited to the stock price increase minus the premium paid.
- Total Loss: You can lose your entire investment if the option expires worthless.
Important Considerations
- Stock Selection: Choose financially sound companies with long-term growth potential.
- Strike Price: Select a strike price that aligns with your bullish outlook.
- Timeframe: Give yourself ample time for the stock to move in your favor.
- Risk Tolerance: Assess your comfort level with the potential for losses.
Conclusion
LEAPS options can be a valuable tool for long-term investors seeking capital efficiency and
potential leverage. However, the “70% discount” claim is a simplification, and investors
must understand the risks involved. Careful stock selection, strike price selection, and
risk management are essential for successful LEAPS trading.
Related Keywords
LEAPS options, long-term equity anticipation securities, LEAPS trading strategy, LEAPS
call options, LEAPS put options, options trading, options trading for beginners, options
leverage, options investing, options strategies.
Frequently Asked Questions (FAQ)
1. What are LEAPS options?
LEAPS (Long-term Equity Anticipation Securities) are long-term options contracts with expiration dates that are typically a year or more in the future.
2. What is a call option?
A call option gives the buyer the right, but not the obligation, to buy 100 shares of a stock at a specific price (strike price) before the expiration date.
3. What is a put option?
A put option gives the buyer the right, but not the obligation, to sell 100 shares of a stock at a specific price (strike price) before the expiration date.
4. What does “in-the-money” (ITM) mean for an option?
A call option is ITM when the stock price is above the strike price. A put option is ITM when the stock price is below the strike price.
5. What does “out-of-the-money” (OTM) mean for an option?
A call option is OTM when the stock price is below the strike price. A put option is OTM when the stock price is above the strike price.
6. Can I really buy stocks at a 70% discount with LEAPS?
The “70% discount” idea is misleading. You’re paying a premium for the right to buy the stock at the strike price, not for the stock itself.
7. How can LEAPS be used strategically?
LEAPS can be used for long-term bullish bets, capital efficiency, leverage (with caution), and income generation through covered calls.
8. What are the risks of trading LEAPS options?
Risks include time decay, volatility, limited upside potential, and the potential for total loss if the option expires worthless.
9. What are the key factors to consider when trading LEAPS?
Consider stock selection, strike price selection, timeframe, and your risk tolerance.
10. Are LEAPS a suitable investment for beginners?
LEAPS can be complex and involve significant risk. They are generally more suitable for experienced investors with a good understanding of options.
