For years, investors and traders have used options to achieve higher returns than regular stocks provide. However, options could only be used effectively by a small number of investors due to the complicated nature of the investment. Most options expire worthless, increasing the risk for average investors to unreasonable levels. There exists a different way to buy options that allows the buy and hold investor to take advantage of this alternative way to invest. These are called LEAP options.
Difference in Options
The main difference between regular options and LEAP options is the length of the option and when it expires. Most regular options expire in a few months. This puts more pressure on the option buyer to be correct about the underlying product’s move. LEAP options, on the other hand, can have an expiration date of up to three years. It’s much easier to predict a stock’s or index’s move in three years than in a couple of months. Investors can still practice a buy and hold strategy with LEAP options without spending as much buying a stock outright. But otherwise, LEAP options are the same. They can be bought and sold as calls and puts and sold before their expiration.
A Warning about Risk
When talking about options, it should always be stated that they come with extra risk than other investments like stocks or bonds. Unless the company behind a stock or the debtor behind the bond goes bankrupt, investors will always have some value in that investment. Option purchasers will lose all their investment if they don’t either sell the option or exercise it. Investors need to understand their entire investment could go to zero. Of course, this extra risk explains the extra rewards that come from option investing.
Most strategies with LEAP options only involve buying calls and puts. Selling LEAP options comes with even more risk than regular options since there is a longer time for the option buyer to exercise the option. Naked LEAP option selling should only be considered by “sophisticated” investors. One of the best uses for LEAP options is investing for a bull or bear market. Many periods the stock market can be classified as either being in a bear or bull stage, but these market directions aren’t always consistent in month-long periods. LEAP options can take advantage of long time amounts, allowing investors to make money off stock indexes. LEAP options can also be used to buy stocks that will increase overall in the long term, but face a rough road ahead in the short term.
LEAP options allow buy and hold investors to effectively hedge their stock holdings without needing to buy options every three months or so. This allows for reduced costs and, maybe more important, reduced upkeep required for an account. It gives investors greater peace of mind in a stock market that is increasingly turbulent.
Greater Profit, Less Risk
The whole goal of option investing is to reduce one’s risk while increasing one’s profit. LEAP options allow investors to do this, especially the investors who don’t trade and have a long term outlook. LEAP options gives larger positions to investors with less risk than buying stock on margin. They are a great way for investors to improve their portfolio in today’s uncertain climate.
CBOE LEAP options strategies: http://www.cboe.com/strategies/DefaultLeaps.aspx