A LEAP, or Long-Term Equity AnticiPation Security, is simply an option with a longer lifespan. Nothing more, nothing less. LEAPS are available on many securities and indexes, and like traditional options list both calls and puts.
Given the fact that LEAPS and standard options are essentially the same, it begs the question:
When should I consider a LEAP instead of a regular option?
The answer to this question is: It depends…
If you are looking for a short-term move in the underlying or a significant change in implied volatility levels, you may be best off using regular options.
If you are looking at a long-term play i.e. a stock moving higher over a period of several months or more, you may be best off using a LEAP.
Using a LEAP for a longer-term bet on a stock has two distinct advantages:
- The option will hold its value for a longer period of time. Because LEAPS may be purchased with over two years until expiration, the effects of theta may be minimized. The longer time period until expiration also gives the underlying more time to move in the desired direction. Many option traders end up being right about market direction, but the anticipated moves often happen too late – once the investor’s option has already expired – thus producing a loss. A LEAP may potentially help minimize the likelihood of your option expiring worthless.
- Buying a LEAP may require a fraction of the capital you would need to buy the shares outright. If you were to go long 100 shares of stock ABC at $80 per share, you would need $8000 in cash (without using margin). On the other hand, you could potentially purchase a LEAP option for several hundred dollars. Owning a LEAP call option with a $90 strike price, for example, would give you the right, but not the obligation, to be long the shares at $90. If the stock rises to $120 over the next year, the ROI for the LEAP could potentially be considerably higher than the ROI for a straight long position in the shares.
Regular options may potentially be a better fit for short-term moves and volatility plays. In addition, option sellers would likely prefer regular options due to their higher rate of time decay.
If you are looking for a long-term, sustained move in a market, however, a LEAP may potentially provide more value and better chances of success.
