Using LEAPS to invest in options is an excellent way to think about the future. They are highly beneficial, and even a tiny movement in stock prices can result in significant long-term equity.
But LEAPS can also bring high losses, especially if you don’t use them correctly.
For that purpose, we will guide you through three LEAP options strategies that will help you understand how they work and how you can use them the right way.
LEAP Options Strategies - A General Overview
LEAPS (Long-term Equity Anticipation Securities) are option contracts with an extended expiration date beyond one year. You can use them to generate income with three strategies:
- Buying LEAP calls
- Buying LEAP puts
- Rolling LEAPS forward
LEAP strategies are similar to many short-term options strategies. The difference is that they consist more of buying strategies because of the slower decay rate over time.
The similarity between LEAPs and short-term options is also visible during the purchase and selling process and the expiration types. Namely, LEAPs can also have both European- and American-style expirations.
LEAP Options Strategies - A Detailed Overview
There are four main option trading strategies that you can implement to take advantage of LEAPs and make large profits.
LEAPS are like any other options contract, the main difference being the expiration date, which must be at least one year when using LEAPs.
Let’s take a look at the LEAPs strategies.
Buying LEAP calls
Reason and advantage for using them
You can purchase LEAP calls if you predict that the price of a specific stock will rise in the next several years.
In this case, the advantage of LEAP calls is that you will profit from the price rise without purchasing any shares of the given stock.
A practical example of buying LEAP calls
We need to look at a practical example to understand this strategy best.
Let’s say a stock at a particular company has a current value of $99.50.
At the same time, a LEAP call option with an expiration date of three years has a strike price of $90 and is trading for a premium price of $10 per share or $1,000 per contract (1 contract = 100 shares).
You decide to purchase two LEAP calls contracts for $2,000. With this, you enter a call position, and your total risk is the invested amount.
The two contracts you purchased give you the right to buy 200 shares from that company at any time until the expiration date for $90, even though the strike price will go up in the future.
For this strategy to be profitable, the stock must have a strike price above $100 (the strike price + the premium you paid for one share). This price is also called “the break-even point.”
Possible outcomes of the buying LEAP call strategy
This strategy can have three possible outcomes:
The future stock price is below the strike price and the break-even point
If the future stock price is below the strike price ($90), the LEAP calls will have no value, and you will gain no profit. Your total loss will be the $2,000 you invested.
The future stock price is above the break-even point, and the strike price
If the future stock price rises and reaches an example price of $150 at the expiration, then the two LEAP calls contracts you purchased will have a value of $60 (the stock price - the strike price).
You can then exercise the call contracts and purchase the shares at $90 or sell the LEAP calls contracts for a profit.
The future stock price is between the strike price and the break-even point
If the future stock price is between the strike price and the break-even point, you will only suffer a partial loss.
The important thing here is to exercise the LEAP call options to take advantage of the partial loss. If you don’t and the options expire, you will lose all of the initial investment.
Buying LEAP puts
Reason and advantage for using them
Purchasing LEAP puts protects an investor's position from high declines in stock prices. In other words, they represent insurance in case of lousy market fluctuations and price declines.
The main advantage of using LEAP puts is that they give you the confidence to continue trading on the market, hoping the situation will improve.
A practical example of buying LEAP puts
Let’s consider that a stock at a particular company has a current value of $100.
At the same time, LEAP put options have a strike price of $90, selling for $10 per share ($1,000 per contract).
By purchasing these puts, you enter a protection zone, where any price decline of the stock below $80 (break-even point) will be considered a profit.
The total loss is the amount you pay for purchasing the LEAP put contracts (one or more).
Possible outcomes of the buying LEAP puts strategy
This strategy can also have three possible outcomes:
The future stock price is below the break-even point, and the strike price
If the stock price expires below the break-even point ($80), this position will generate a profit depending on the cost of the stock.
For example, if the stock price drops to $70, the put has a value of $20, or $2,000, for the entire contract upon exercise. The estimated profit is $1,000 per contract (the strike price - the future cost of the stock).
The future stock price is above the break-even point, and the strike price
If, for example, the future stock price reaches a value of $110 upon the put contract expiration, then an unexercised put will be worthless. This will result in a loss of the total premium you paid, or $1,000 per contract.
Otherwise, a timely exercised LEAP put, in this case, will result in a profit, valued as the difference between the price of the future stock and the strike price.
The future stock price is between the strike price and the break-even point
When the future stock price is between the strike price and the break-even point, the loss is only partial, but only if you exercise the LEAP put option. The amount of the loss depends on the value of the stock price.
Rolling LEAPS forward
Reason and advantage for using them
“Rolling LEAP” is a term that you will hear frequently.
Many traders often use rolled LEAP options strategies to prolong the time it takes for LEAP call options to become profitable.
In other words, when a trader has purchased LEAP call options, and the stock price is between the strike and break-even points at the time they expire, that is when rolled LEAP is beneficial.
A practical example of rolling LEAP
Let’s assume that stocks at a particular company have a current value of $80.
At the same time, LEAP call options are available with a strike price of $70, selling for a premium of $5 per share ($500 per contract) for three years.
You purchase three LEAP call contracts worth $1,500, which is the maximum amount you can lose with this trade.
When the contracts expire after three years, you will either make a profit or lose your investment. But if the future price of the stocks is between the strike price and break-down point, then there is an option to prolong the contracts using the rolling LEAP strategy.
In other words, you can replace an old LEAP option with a new one, extending its duration. For example, you can hold a three-year LEAP option for two years, then sell it for a new LEAP option that lasts a further three years.
Are rolling LEAPS beneficial?
Rolling leaps can be beneficial for stocks and securities with low volatility. That is because the price changes with these stocks are inexpensive. Thus, the losses and the overall risk are minimal.
Rolling a LEAP forward is inexpensive because you practically substitute one option with a similar one, only extending its duration.
Conclusion
The use of LEAPS has become increasingly frequent, even though it doesn’t make sense to many traders and investors.
Many think that it turns secure but small profits into high-risk gambling ones and that you would need a miracle to predict the correct movement of prices in the long term.
But using some of the LEAP options strategies we’ve covered, you will certainly have more confidence when investing your money in the long run, with the resulting profit as a great motivator.
To get started using LEAPS, we recommend you try the FoolProof Options trading platform, which has everything you need to get started.
Good luck and happy trading!