What are LEAP options?

LEAP Options

Definition of LEAP Options

LEAP Options Time Decay

LEAP Option Example

LEAP Covered Calls

Related Terms:

Definition of LEAP Options

LEAP Options are just like regular monthly options except that they expire more than 1 year from today. LEAP stands for Long-term Equity Anticipation Security.

Just like shorter term put and call options, LEAPs are a lower cost way to control 100 shares of stock. If you think a stock will be higher a year from now you can buy a LEAP call option instead of 100 shares of stock; it will cost less. Likewise, if you think a stock will be lower in a year, you can buy a LEAP put option instead of shorting the stock or buying a series of shorter term puts.

Time Decay Of LEAPs

Unlike weeklys, the time decay in LEAPs is very slow. Assuming you exit the LEAP while it still has 6 months or more to go until expiration, you are unlikely to lose much value in the form of time decay. (If the underlying stock moves wildly while you hold the LEAP then you will make or lose much more from that action than from the passage of time.)

Example of a "LEAP Option"

Let's say today is Thursday, March 26, and let's say you like Apple (AAPL) stock. If you look up the monthly options available you will find expiration dates of:

  • Apr 17 (21 days from now)
  • May 15 (49 days)
  • Jun 19 (84 days)
  • Jul 17 (112 days)
  • etc... (every 3rd Friday of each month)

But if you'd rather not spend over $10,000 for 100 shares of Apple, and if you don't want to be time constrained and subject to time decay of shorter term options, then you could buy a LEAP option instead. Current long term expiration dates are:

  • Jan 15, 2016 (289 days), not a LEAP (less than a year)
  • Jan 20, 2017 (660 days), this is a LEAP (more than a year)

You could buy a Jan 2017 LEAP call option with an at-the-money strike price of 125 for $17.50. That means for $1,750 you control 100 shares of AAPL between today and Jan 20, 2017. That's a lot less expensive than buying 100 shares at today's price of 124.49, which would cost $12,449. If you buy the LEAP call option you still have all the upside but, on the downside the most you can lose is $1,750. If AAPL drops to $75 (for example) by Jan 2017 then the LEAP call buyer would only lose $1,750, whereas the AAPL stock buyer would lose almost $50K.

LEAP Covered Calls

Some people like to buy a LEAP call option as an alternative to buying the stock, and then using that LEAP as the basis to write shorter term covered calls. This is more capital efficient than buying the shares, but does have a few drawbacks:

  • You don't collect dividends if you own call options. If you're going to hold the stock for a couple of quarters that means you'll miss at least 2 dividends compared the person who owns the shares.
  • You are at risk of early exercise on the shorter term, short call option you sold. If that happens you will either have to go into the market and buy shares to fulfill your obligation, or you will have to exercise your LEAP so you can deliver the shares (and exercising a LEAP is not a good strategy because you will forfeit any time premium that remains in the option).
  • Volatility could fall after you purchase the LEAP, which would reduce it's value, even if no time has passed and the underlying stock price hasn't moved. There is no guarantee that the volatility will return.
  • Bid-ask spreads on LEAPs are quite wide, making it costly to roll or exit the position if you want to.

Still, having said all that, it is a more leveraged and capital efficient way to do a covered call. Just be aware of the risks.

Now that you know the basics, keep reading to get some specifics about calls and puts:

  1. LEAP Covered Writes
  2. What is a Covered Call?
  3. What is a Call?
  4. What is a Put?
Options Trading

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