Given that markets are currently sitting at multi-year or record highs, you may not want to take on significant positions because of the uncertainties and threat if downside weakness. The fact is buying large positions will expose your capital to downside risk. To help minimize the risk and control the capital that you put at risk, you may want to consider long-term options called Long Term Equity Anticipation Securities or LEAPS.
LEAPS are call or put options characterized by a time to expiry of more than nine months to three years from the time of purchase. The extended time period allows your strategy to play out. The only disadvantage is the larger premium that you need to pay for the LEAPS. Hence, the stock would have to rise or fall much more than shorter-term options in order to make money.
Versus holding the same amount of the actual stock, the risk is less due to the leverage involved in LEAPS and options in general. For instance, you can play 100 shares of Google Inc. (NASDAQ/GOOG) for a fraction of the cost by using LEAPS. Let’s say you are interested in 100 shares of Google. Trading at $506.15 (November 24), the capital outlay would be $5,061 excluding commissions. But you can alternatively buy one contract (each contract represents 100 shares) of the January 2009 Google $500 LEAPS for $1,180. For about 23.31% of the total capital required for the stock position, you can partake in the move of the same number of shares via the Google LEAPS. And you have over two years to expiry of the LEAPS.
The upside breakeven is $618 ($500 strike plus $118 premium). As long as Google breaks above $618 by January 16, 2009, you will make money. But, if Google begins to sink, your capital risk is far less via the LEAPS.
For the more conservative investors or option traders, LEAPS provide an excellent alternative to a “buy and hold” strategy because of the leverage involved, as well as the management of risk.
The correlation between LEAPS and the underlying stock and the fact it has a long shelf life makes it an increasingly attractive vehicle for the more conservative investor.
In general, LEAPS call (put) option on stocks will move up (down) dollar-for-dollar with the underlying stock above (below) the breakeven point.
As an investor, LEAPS could be used in many scenarios.
For instance, a conservative investor can actually build a diversified LEAPS stock portfolio encompassing large-cap stocks, including the majority of household brand name stocks.
Investors with a smaller asset base can build a diversified portfolio at a fraction of the cost versus the actual ownership of the stock. Moreover, your percentage returns from a LEAPS strategy could even prove more superior then holding the actual stock if the price rises.
LEAPS can also be purchased on the major market indices.
The LEAPS portfolio can be conservative or more aggressive, depending on your investment. You can find a complete list of available LEAPS at http://www.cboe.com.