Given the current volatility in stocks, you may not want to take significant positions because of the uncertainties and threat if downside weakness. Buying large positions exposes 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 Equity Anticipation Securities or LEAPS.
LEAPS are call or put options characterized by a time to expiry of 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 much less due to the leverage involved in LEAPS and options in general. For instance, you can play 1,000 shares of General Electric Co. (NYSE/GE) for a fraction of the cost by using LEAPS.
Let’s say you are interested in 1,000 shares of GE. Trading at $32.60, the capital outlay would be $32,600 excluding commissions. But, you can alternatively buy 10 contracts (each contract represents 100 shares) of the January 2009 GE $30 LEAPS for $5,800 ($580 a contract excluding commissions). For about 17.79% of the total capital required for the stock position, you can partake in the move of the same number of shares via the GE LEAPS.
The upside breakeven is $35.80 ($30 strike plus $5.80 premium). As long as GE breaks $35.80 by January 16, 2009, you will make money. But if GE 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 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 www.cboe.com.