Should You Make It a LEAP Year?

Long term assets are tricky things.

How you plan for an option contract depends, in large part, on how long you intend to hold it. A position that stays open for a few weeks can be built around one expected movement or momentary volatility. By contrast, over the course of a year, that same asset will undergo many different shifts.

Investing around that kind of timeframe is where LEAPS come into play.

What are LEAPS?

LEAPS stands for “Long-term Equity Anticipation Securities.” (The acronym borrows the “P” from anticiPation.)

In a nutshell, a LEAP security is any position held for more than nine months. There’s nothing special about how you structure or purchase LEAPS; they just stay open for an unusually long time.

In the world of LEAPS, timing is, as they say, everything. (Speaking of timing, there is no better time than right now to try Market Timer for one month at an introductory low price.)

How are they different?

While the structure of LEAP securities doesn’t change, they require a different approach than swing trades or ordinary option contracts simply because a lot can happen in a year. That can be very helpful (as you’ll see below), but it’s also pretty unusual for an options trader. This is typically an industry that moves much more quickly and tends to measure positions in a few months at most.

Options contracts are built around predicting what price a stock will meet or pass within a certain timeframe. That means, largely, figuring out the trend and magnitude of coming volatility with some specificity.

Unlike a stock, it’s not enough to predict direction (will the asset go up or down); you need to peg that movement to a price it will meet or exceed and by when. That kind of specificity makes LEAP trading, or as it’s otherwise called “buy-and-hold,” harder for an options trader.

But it’s not impossible.

Volatility and Extrinsic Value

LEAPS have a few advantages, but one of the biggest is that they smooth out volatility.

Some edges need to be smoothed out.

With trading, as with any other data, patterns become easier to see over time. Now, that does no good for a trader who wants to profit off specific events or an upcoming shift in the market, but then again, that kind of trading doesn’t help someone who wants to profit off the long-term fundamentals of a stock.

LEAPS are how you can step back and decide to invest in a company’s overall strength or weaknesses. With months, or even a year or more, momentary volatility will smooth out, leading to a considerably more predictable investment (all things being equal). It is, in a way, an options contract for people who want to look at the big picture.

However, be careful. As has been discussed in this space before, time is a major factor in extrinsic value. As a general rule, LEAPS have more expensive premiums simply because with more time comes more predictability, and more chances that the contract seller will lose his or her money.

Rolled LEAPS

LEAPS also have value for long-term investors as a stock substitute.

Over a long period of time, investing in stocks and mutual funds has many advantages, most notably that you need to predict their movement with far less precision (as noted above). However buying those assets involves tying up a lot more money and risking far greater losses in the event of a downturn.

That’s why some investors turn to LEAPS instead. A long-term option can simulate many of the gains of buy-and-hold investing, allowing you to profit from the stock’s overall rise in value while limiting your capital exposure to the premiums paid up front.

Your contract has to have an expiration date; it can’t last indefinitely. The solution is to, at the expiration, sell the contract and replace it with an identical one timed for another year. Premiums on this are generally low, especially if you can match the premium with the sale price of your previous contract. In function, you roll over the investment year to year. Hence the name.

When you are ready to jump into the world of options trading, Best Choice has the tools to help you get it right. Try us risk free  today!

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