LEAPS: Options for the Long Term - Part 1
INTRODUCTION
When considering any options strategy, you may want to think about Long-Term Equity Anticipation Securities (LEAPS) if you are prepared to carry the position for a longer term. While using LEAPS does not ensure success, having a longer amount of time for your position to work is an attractive feature for many investors. In addition, there are several other factors that make LEAPS useful in many situations.
STOCK ALTERNATIVE
LEAPS offer investors an alternative to stock ownership. LEAPS calls enable investors to benefit from stock price rises while placing less capital at risk than is required to purchase stock. Should a stock price rise to a level above the exercise price of the LEAPS, the buyer may exercise the option and purchase shares at a price below the current market price. The same investor may sell the LEAPS calls in the open market for a profit.
DIVERSIFICATION
Investors also use LEAPS® calls to diversify their portfolios. Historically, the stock market has provided investors significant and positive returns over the long term. Few investors purchase shares in each company they follow. A buyer of a LEAPS call has the right to purchase shares of stock at a specified date and price up to three years in the future. Thus, an investor who makes decisions for the long term can benefit from buying LEAPS calls.
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HEDGE
LEAPS puts provide investors with a means to hedge current stock holdings. Investors should consider purchasing LEAPS puts if they are concerned with potential price drops on stock that they own. A purchase of a LEAPS put gives the buyer the right to sell the underlying stock at the strike price up to the option's expiration.
WHAT'S THE DOWNSIDE?
If you are a buyer of LEAPS calls or LEAPS puts, the risk is limited to the price you paid for the position. If you are an uncovered seller of LEAPS calls, there is unlimited risk, or a seller of LEAPS puts, significant risk. Risk varies depending upon the strategy followed, and it is important for an investor to understand fully the risk of each strategy.
STOCKS VS. LEAPS
There are many differences between an investment in common stock and an investment in options. Unlike common stock, an option has a limited life. Common stock can be held indefinitely, while every option has an expiration date. If an option is not closed out or exercised prior to its expiration date, it ceases to exist as a financial instrument.
As a result, even if an option investor correctly picks the direction the underlying stock will move, unless the investor also correctly selects the time frame that movement will take place, the investor will not profit as desired.
Continued in Part 2...
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About The Options Industry Council
The Options Industry Council (OIC) was created in 1992 to educate investors and their financial advisors about the benefits and risks of exchange-traded equity options. Today, its sponsors include the American Stock Exchange, the Boston Options Exchange, the Chicago Board Options Exchange, the International Securities Exchange, NYSE Arca, the Philadelphia Stock Exchange and The Options Clearing Corporation. Our experienced options seminar instructors provide valuable insight on the challenges and successes that individual investors encounter when trading options. In addition, options industry professionals have created the content in our software, brochures and Web site. Appropriate compliance and legal staff ensure that all OIC-produced information includes a balance of the benefits and risks of options.
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