Today I will touch upon another option trading strategy that I often use in addition to holding or trading stocks. In past commentaries, I have discussed basic option strategies involving calls, puts, and two-sided trades such as straddles.
The other day, someone asked me about holding long-term options that would fit a “buy and hold” strategy. In a situation like this, Long Term Equity Anticipation Securities or LEAPS make sense.
Basically, 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 period allows your strategy to play out. The only disadvantage is the larger premium that you need to pay. You see, the stock would have to rise or fall much more than shorter-term options in order for you to make money.
Compared to shorter-term options, LEAPS have four distinct features — more expensive, less speculative, time is not a major factor, and lower risk/lower reward. While shorter-term options are generally advised only for more aggressive traders, LEAPS are generally more conservative, since the window of opportunity is longer.
For the more conservative investors or options 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, as well as the fact that LEAPS have a long shelf life, makes these investments an increasingly attractive vehicle for the more conservative investor.
In general, LEAPS call (put) options 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 of actually owning the stock. Moreover, your percentage returns from a LEAPS strategy could prove superior over those from holding the actual stock if the price rises.
The LEAPS portfolio can be conservative or more aggressive, depending on your investment.