Long-term equity anticipation securities (LEAPS) are option contracts with expiration dates of nine months or more into the future. LEAPS are traded the same as other option contracts. The advantage is the ability to make investment decisions that implement long-term investing strategies. Using LEAPS, these strategies are not as influenced by shorter-term moves in the underlying asset as a front-month option contract would be.
Recalling the material from lesson 1.6, as the expiration date approaches the extrinsic value of an option contract decays at a greater rate. Therefore, LEAPS limit the decay of the extrinsic value of an option contract because of their longer lifespan. Of course, the option premium will reflect the added extrinsic value, meaning premiums will be higher in most cases.
An investor who already owns stock can use LEAPS options as a way to hedge long-term investments.
An investor owns 100 shares of IBM in their portfolio. They plan is to hold the stock for many years. By purchasing a LEAPS put option on IBM, the investor has the right, but not the obligation, to sell their IBM stock at the strike price of the contract any time before expiration.
Also, investors use LEAPS options to profit from long-term trends in the underlying stock.
An investor is bullish long term on Ben Franklin Resources and wants to be able to purchase the stock at $105 per share any time between now and expiration. By purchasing a LEAPS call option, the investor has the ability to do this and profit from a continued rise in the stock. If the stock does not rise over the next year, the LEAPS option simply expires worthless and the investor never has to take possession of the underlying stock.
Deep In-The-Money LEAPS option contracts are used to control 100 shares of the underlying stock without having to allocate the capital required to actually own the underlying stock.
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