SteadyOptions is an options trading forum where you can find solutions from top options traders. Join Us!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

LEAP Options Explained: What Are They And How Do They Work?


Investors that are looking to make longer-term bets may use LEAP Options. They are functionally identical to most other listed options, except with longer times until expiration. These contracts are ideal for options traders looking to trade a prolonged trend.

Description of LEAP Options

A LEAP option is essentially an option with longer terms than standard options. The acronym "LEAP" stands for Long Term Equity Anticipation Security and like standard options, LEAPS come in two forms: calls and puts.

 

These long-dated options are available on approximately 2500 securities and several indexes. Standard options are typically available in monthly cycles, and many are now also available in weekly cycles.

 

LEAPS, on the other hand, may extend out for a couple years and always expire in the month of January.

 

An investor may use LEAPS if they are bullish or bearish a stock or index, but think that there opinion may take some time to play out. For example, suppose that investor Bob is bullish on stock ABC which is currently trading at $40 per share.

 

Bob thinks the company has great fundamentals, and it is currently in the process of bringing several new products to market. Bob thinks the stock price could potentially go to $80 per share or even higher if the company is successful with the launch of its new products. Bob's understanding is that the products may take anywhere from 9-15 months to bring to market.

 

Bob could simply buy shares of ABC at $40 per share now and hope that the stock price does climb in the months ahead. That, however, could tie up a great deal of Bob's investment capital for a significant period of time. Bob makes the decision to purchase a LEAP call option that expires in one year with a strike price of $55 per share for a premium of $5.00

 

Bob's risk is now limited to the $5 premium he paid for the call option. His potential upside is technically unlimited. If the stock price is below the option strike price of $55 at expiration, Bob will lose the entire $5 premium paid.

 

If the stock rockets higher, however, Bob could potentially profit point-for-point once the share price rises above the break-even level of $60 per share. If the share price were to climb to $85, for example, Bob could potentially see a profit of $25 per share.

 

At that point, Bob could simply sell the option back to the market or he could exercise is options to obtain a long position in the stock at $55.

 

When To Put It On

LEAP options may be used to make long-term bets on a stock or index going up or down.

 

A call option can be put on when one is bullish the stock, but thinks their bullish thesis will take some time to develop. A put option can be put on if one is bearish on a stock, but again thinks that their bearish thesis may take some time to unfold.

 

In this way a high positive delta LEAP call is often used as a low capital required stock replacement strategy.

LEAPs may also be used to hedge a long or short position in a stock or index. If an investor owns shares in company YYY, which pays a handsome dividend, then he or she may look to purchase long-term puts to hedge their downside risk.

 

Pros of LEAP options

LEAPS may have numerous potential benefits. If LEAPS are purchased, then the maximum risk of the position is limited to the premium paid. LEAPs may also potentially allow for a better use of capital and higher ROI.

  • The long timeframe of a LEAPS contract allows you to sell the option.
     
  • You can use a LEAPS contract to hedge your bets against fluctuations in your overall long-term portfolio.
     
  • The prices for LEAPS are not as sensitive to the movement of the underlying asset. If the underlying asset's price changes, the price for the contract won't necessarily make a big move itself.

 

Cons of LEAP options

LEAPs also have some negatives as well. if one is buying LEAP options, those options will lose value over time as the effects of theta, or time decay, take a toll with all other inputs remaining constant. Options can also be affected by changes in implied volatility, potentially fueling gains or losses. Due to the amount of time premium that may be built into LEAPs, they may also be cost prohibitive.

The prices for LEAPS are highly sensitive and subject to market volatility and interest rate fluctuations.

 

Risk Management

LEAP options can be managed just like standard options with some caveats. An investor could simply decide, for example, to cut their losses once the value of an option declines by a specified amount. Investors may also potentially choose to cut a position once the option reaches a certain amount of time until expiration.

 

LEAPs may be less liquid than standard monthly or weekly options, however, so risk management could potentially become more challenging. For investors that sell LEAP options, the risk is unlimited on the upside and only limited by zero on the downside (since a stock can go to zero).

 

Only investors with a solid understanding of options and the risks involved with selling options should attempt LEAP selling strategies. Even then, losses may not be avoided and investors must be willing to assume the unlimited risks involved.

 

Investors may, however, limit the risk of selling a LEAP option by purchasing another option further out-of-the-money, creating a limited-risk credit spread.'

 

Possible Adjustments

LEAP positions may be adjusted using various methods like standard options if liquidity is not an issue.

 

Strike prices may be adjusted as well as expiration dates. For example, if a LEAP is approaching its expiration date but the investor still believes a big run higher may be seen in the months ahead, he or she could sell their LEAP call option back to the market and purchase a new LEAP call option that expires the following year.

 

Used under the appropriate circumstances, LEAP options can be a useful tool for betting on market direction as well as hedging exposure in the underlying stock or index.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

Subscribe to SteadyOptions now and experience the full power of options trading at your fingertips. Click the button below to get started!

Join SteadyOptions Now!

 

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Real-time trade sharing: entry, exit, and adjustments

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Subscribe to SteadyOptions now and experience the full power of options trading!
Subscribe

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • SPX Options vs. SPY Options: Which Should I Trade?

    Trading options on the S&P 500 is a popular way to make money on the index. There are several ways traders use this index, but two of the most popular are to trade options on SPX or SPY. One key difference between the two is that SPX options are based on the index, while SPY options are based on an exchange-traded fund (ETF) that tracks the index.

    By Mark Wolfinger,

    • 0 comments
    • 433 views
  • Yes, We Are Playing Not to Lose!

    There are many trading quotes from different traders/investors, but this one is one of my favorites: “In trading/investing it's not about how much you make, but how much you don't lose" - Bernard Baruch. At SteadyOptions, this has been one of our major goals in the last 12 years.

    By Kim,

    • 0 comments
    • 876 views
  • The Impact of Implied Volatility (IV) on Popular Options Trades

    You’ll often read that a given option trade is either vega positive (meaning that IV rising will help it and IV falling will hurt it) or vega negative (meaning IV falling will help and IV rising will hurt).   However, in fact many popular options spreads can be either vega positive or vega negative depending where where the stock price is relative to the spread strikes.  

    By Yowster,

    • 0 comments
    • 782 views
  • Please Follow Me Inside The Insiders

    The greatest joy in investing in options is when you are right on direction. It’s really hard to beat any return that is based on a correct options bet on the direction of a stock, which is why we spend much of our time poring over charts, historical analysis, Elliot waves, RSI and what not.

    By TrustyJules,

    • 0 comments
    • 468 views
  • Trading Earnings With Ratio Spread

    A 1x2 ratio spread with call options is created by selling one lower-strike call and buying two higher-strike calls. This strategy can be established for either a net credit or for a net debit, depending on the time to expiration, the percentage distance between the strike prices and the level of volatility.

    By TrustyJules,

    • 0 comments
    • 1,475 views
  • SteadyOptions 2023 - Year In Review

    2023 marks our 12th year as a public trading service. We closed 192 winners out of 282 trades (68.1% winning ratio). Our model portfolio produced 112.2% compounded gain on the whole account based on 10% allocation per trade. We had only one losing month and one essentially breakeven in 2023. 

    By Kim,

    • 0 comments
    • 5,888 views
  • Call And Put Backspreads Options Strategies

    A backspread is very bullish or very bearish strategy used to trade direction; ie a trader is betting that a stock will move quickly in one direction. Call Backspreads are used for trading up moves; put backspreads for down moves.

    By Chris Young,

    • 0 comments
    • 9,486 views
  • Long Put Option Strategy

    A long put option strategy is the purchase of a put option in the expectation of the underlying stock falling. It is Delta negative, Vega positive and Theta negative strategy. A long put is a single-leg, risk-defined, bearish options strategy. Buying a put option is a levered alternative to selling shares of stock short.

    By Chris Young,

    • 0 comments
    • 11,133 views
  • Long Call Option Strategy

    A long call option strategy is the purchase of a call option in the expectation of the underlying stock rising. It is Delta positive, Vega positive and Theta negative strategy. A long call is a single-leg, risk-defined, bullish options strategy. Buying a call option is a levered alternative to buying shares of stock.

    By Chris Young,

    • 0 comments
    • 11,517 views
  • What Is Delta Hedging?

    Delta hedging is an investing strategy that combines the purchase or sale of an option as well as an offsetting transaction in the underlying asset to reduce the risk of a directional move in the price of the option. When a position is delta-neutral, it will not rise or fall in value when the value of the underlying asset stays within certain bounds. 

    By Kim,

    • 0 comments
    • 9,659 views

  Report Article

We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs