Benefits of Trading LEAPS

Most retail investors would see their options profits grow exponentially if they owned longer dated options known as LEAPS, instead of shorter dated call options. The first benefit of LEAPS options, or Long-term Equity Anticipation Securities, is that they allow more time to be right about the direction of an underlining security.

Let's use the imaginary stock XYZ as our example. Right now XYZ is trading at $50, and we own the right to buy one contract of XYZ for $725. If XYZ stock starts to increase, so does the price of the option. Remember, when there’s a small movement in the stock there's a magnified movement in the LEAPS option.

Another benefit of trading LEAPS options is that an option will always cost less than the actual shares of stock. For example, if XYZ stock were trading at $50 a share, 100 shares would cost $5,000. But the right to control 100 shares, referred to as 1 contract, in the form of LEAPS options would only cost $7.25 per share, which brings our total cost to $725 as opposed to the $5000 cost of actually owning the stock. This means less cash out of your pocket leaving you free to do more with your money.*

We can clearly see in the graph below that the purchase of 400 LEAPS options is still less than the outright purchase of 100 shares of the same stock.

How would you know when to purchase a LEAPS call option or a LEAPS put option? The answer is simple. If you expect the stock to rise you would purchase a LEAPS call option. This call option would expire at least a year from now and as the stock rises, the value of your call option would increase.

If you want to be conservative in your LEAPS perspective you would purchase a deep in the money call option with a delta of +.7 or higher. That way your LEAPS call option would have some intrinsic value.

If you expected a stock to decline in value you would purchase a LEAPS put option. Therefore, if the stock started to decrease, the value of your put option would start to increase.

If you're unsure about the direction of a stock, whether it's going up or down, you could purchase one LEAPS call option and one LEAPS put option. You could also simultaneous bring in monthly income by selling covered calls.

Trading LEAPS contracts allows individual investors just like you to amass large amounts of profit within a small period of time. What stock trades work best with LEAPS? That’s all a matter of profits and strategy.

Call Options

Before we can make big profits from call and put options we have to understand how they work and function. Call and put options are also known as derivatives. They derive their value from the value of the stock. The easiest way to think about a call or put option and its price behavior is that when there’s a small movement in the stock there’s a magnified movement in the option. This rate of change is a measurement referred to as a stock’s delta

Let's take a look at a call option’s price behavior. A call option is a right, not an obligation, to purchase shares of a stock at a particular price known as the strike price. Most self-directed investors only trade stocks. But hedge funds that generate large amounts of profits also trade call and put options, which are rights.

Here’s an example of how a call option reacts when there’s a small increase in the stock price.

Delta +.5 Call Option

If a stock price is at $10, the right to buy that stock, a call option, could be trading for $1. The next day the stock increases from $10 to $11. The value of the right to buy the stock increases 50 cents to $1.50. The following day the stock increases from $11 to $12. The price of the call option increases $2.

From $10 to $12 is a $2 increase in price. You'll notice it's a 100 percent increase in the value of the call option. If you had $1,000 worth of call options on a stock that increased $2, your $1,000 call option would become $2,000.

Taking it to the next level, if you had $10,000 worth of call options in a stock that increase $2, your $10,000 would now be worth $20,000.

If you were a Hedge Fund and had $100,000 worth of call options on a stock that increased in price $2, your call option would now be worth $200,000.

It's this rapid increase in the value of the call option that allows hedge funds and wealthy investors to profit big.*

My more advanced students trade LEAPS options.  LEAPS options trading will take practice and study. If you’d like information on my next Trading LEAPS for Wealth Online Workshop sign up for our FREE newsletter at the top right side of this page.

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* DISCLAIMER:  Stocks and options trading involves risk and is not suitable for every investor. The stocks and options prices vary and, as a result, clients may lose or gain from their original investment.  Stock illustrations posted on TheWealthlyInvestor.net web site are for illustration purposes only. Your personal results as a trader/investor may vary from the WI students listed above.