Do you want to take a LEAP with your long-term investment strategies? Do you even know what that term means? If you don’t – and you’re in good company; most people don’t – this article should explain the basics and give you an understanding of what I’m talking about.
LEAP stands for ‘long-term equity anticipation’, and it refers to a class of options that have longer expiry dates (dates on which the contract expires, or deadlines for action on an option) than traditional options. Options typically are for anywhere from a month to nine months, most commonly offered in intervals of three months. LEAP options give you the right but not the obligation to purchase shares on longer time scales.
Here, I’ll give you an overview of LEAP options and how they can be used for long-term investing strategies. I’ll also cover the risks involved in using these particular options, as well as the offsetting benefits that could be gained by incorporating these securities into your investment plan.
Why LEAP Options Exist
As mentioned, typically options are in relatively-short time intervals of three, six, or nine months. In other words, you could buy an options contract on August 1 and have to exercise the option by November 1 of that year before it expires. This can impact a trader because short-term volatility makes predicting the future value of a stock or other asset more difficult.
LEAP options, by contrast, are usually offered with three-year contract periods, although you can find some with two-year periods. With this increased timespan, you can mitigate some of the short-term volatility that you would normally encounter in an asset over a three-month period, for example.
Risks and Benefits
Risk and benefits of LEAP options largely reflect those with standard options. First we’ll cover the risks.
One risk that applies to LEAP options and standard options alike is the notion that you could lose your entire investment if things go south. For example, you’ll have to pay a premium to buy any option – and that money is gone no matter what happens. If your asset’s value drops, for example, you incur a loss if you exercise the option and buy shares for a higher price than their current value. You’ll also incur a loss if you don’t exercise the option.
You’ll also pay fees, which are generally higher for options than stocks.
There are risks, sure, but there are also potential benefits.
One benefit of any option is the fact that you can leverage a relatively-small amount of capital for a relatively-large return. This can be quite advantageous especially with a LEAP option, as you have a longer time period to work with. A lot can happen over three years versus three months.
LEAP options allow you to take advantage of long-range trends, which are much easier to identify when you have a longer time span. Trying to see what trends will happen in a three-month period is very difficult, even for experienced traders. Even a nine-month time span is hard for trend-spotting.
By the time you’ve identified a trend, the market has likely reversed itself – meaning you could be stuck with quickly-expiring options.
How to Use LEAP Options
How do investors make use of these assets?
There’s nothing wrong with using LEAP options in a straightforward strategy. That is to say, there’s nothing wrong with picking up long-range call or put options and using them to turn a profit. Let’s say you decide to pick up a call option on Facebook (FB), a stock that debuted in May, 2012 for $38 a share only to fall to $20 a share in August. You think FB, over the next three years, will climb in value, so you pick up call options for $30 per share.
You don’t have to hope FB gets to $20 per share over the next three months, or even the next nine months. You just hope that FB climbs over $30 over the next three years, which would be an average annual growth rate of 16.7%. That’s not that bad, especially considering that the $20 price point is 58% lower than the stock’s peak of $45 per share.
(That isn’t to say you should do that; the above is just an illustration using relatively-recent data.)
Another way to use LEAP options is as a long-term hedge. You can buy put options on your positions to mitigate your losses if your long positions turn south. In this case, it’s like buying insurance (because you’re paying a premium).
Learn more about LEAP options and how you can incorporate these specific assets into your portfolio either as a direct play or a hedge.