New option traders often ignore a tremendous tool the options market avails them, and this tool is called LEAPS (Long Term Equity Anticipation Securities). Any equity that has listed options may also have LEAPS available. The only difference between a LEAPS option and a regular option is that LEAPS have a longer time frame. All LEAPS are January options and are usually available for the January of the following year and the year after that. LEAPS can go as far out as 39 months. Once a previous LEAPS has between 6 to 8 months left until expiration, it converts into a normal option.

Just like conventional options, LEAPS options represent the right to buy for calls or sell for puts an underlying asset for a specific price until expiration. Another key piece of information about LEAPS is that when long-term options become short-term options, they are subject to a process known as melding. The melding process occurs after either the May, June or July expiration that precedes the first LEAPS expiration. After that, the LEAPS status and special symbol are removed and the options begin trading like regular short-term options. LEAPS were first listed on the Chicago Board Options Exchange [CBOE] in 1990 to provide those investors who have longer-term time frames with opportunities to trade options. LEAPS are a tremendous way for the option strategist to add flexibility to their options trading approach.

For instance, an investor can use LEAPS put options to protect a stock holding and not have to worry about adjusting the position for up to two and a half years, which also means less in commission charges. Another key advantage to trading LEAPS is that they offer a great alternative to buying and holding stocks outright. For instance, purchasing an in-the-money or out-of-the-money LEAPS calls or out-of-the-money LEAPS bull call spreads can be implemented providing the investor a long-term operating timeframe similar to the traditional buy and hold stock investor, but without committing as much capital to the investment.

LEAPS can effectively be used with some other very profitable and popular option strategies as well. Another key difference between long-term and short-term options is the impact of time decay as time passes and as expiration approaches. The process is not linear, however, because time decay becomes greater as the option’s expiration approaches. Therefore, all else being the same, an option with two years until expiration will experience a slower rate of decay than an option with two months until expiration.

As a result, LEAPS can offer better risk to reward ratios when establishing strategies that require holding long-term options, such as calendar spreads or debit spreads. In fact, you can implement calendarized type covered call strategies like the diagonal call spread and sell premium month after month eventually ending up with a free trade way before the LEAPS actually expires. It is this type of flexibility that makes LEAPS so worthwhile for the option strategist to add to their trading tool chest. By do so it will make you a much better equipped and well armed options trader.

Happy Trading.


Jeff Neal
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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