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Frederic Ruffy, Optionetics.com
June 10, 2002

The acronym LEAPS stands for Long-Term Equity Anticipation Securities.  While the name seems somewhat arcane, LEAPS are nothing more than long-term options.   Some investors incorrectly view these long-term options as a separate asset class.  But in fact, the only real difference between LEAPS and conventional stock options is the time left until expiration.  That is, while short-term options expire within a maximum of eight months, LEAPS can have terms lasting more than 2½ years.  At the same time, however, while the only real distinction between conventional options and LEAPS is the time left until expiration, there are important differences to consider when implementing trading strategies with Long-Term Equity Anticipation Securities and one of the most important is the impact of time decay.

The Chicago Board Options Exchange [CBOE] first listed LEAPS in 1990.  The goal was to provide those investors that have longer-term time horizons with opportunities to trade options.  Prior to that, only short-term options with a maximum expiration of eight months were available.  The exchange labeled the new securities as Long-term Equity Anticipation Securities in order to differentiate between the new contracts and already existing short-term contracts.  According to the exchange, “the name is not important.  It is the flexibility that long-term options can add to a portfolio that is important.”

In order to add flexibility to your portfolio using LEAPS, there are a number of important factors to consider.  First, like conventional options, these options represent the right to buy (for calls) or sell (for puts) an underlying asset for specific price (the strike price) until expiration.  Each option contract represents the right to buy or sell 100 shares of stock.   All LEAPS have January expirations and new years are added as time passes.  For example, the year 2005 LEAPS were created after the expiration of the May 2002 contract. Approximately, one-third of the stocks that already had LEAPS were issued the 2005 LEAPS after the May expiration. The remaining two-thirds will be listed when June and July option contracts expire.

Not all stocks, however, will be assigned long-term options.  For one, in order to have long-term options, the stock must already have listed short-term options.  In addition, according to the CBOE, long-term options are only listed on large well-capitalized companies with significant trading volume in both their stock and their short-term options.  In order to find out if a given stock has LEAPS, simply pull up an options chain on the Optionetics.com home page and see if the stock has options expiring in January 2004 or January 2005.  If so, the stock does indeed have long-term options available.

When long-term options become short-term options, they are subject to a process known as melding.  During that time, the terms of the option contract (the strike price, the unit of trade, expiration date, etc.) do not change.  The symbol assigned to the contract is only thing that changes during the melding phase.   The exchanges generally assign different trading symbols to long-term options to distinguish between the LEAPS and the short-term contract.  Therefore, for bookkeeping purposes, the long-term option is converted to a short-term option and the symbol changes from the LEAPS symbol to the symbol assigned to the conventional options. This 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.  In sum, the terms of the options contract such as the unit of trading, strike price, and expiration date do not change when LEAPS become short-term contracts.  Therefore, neither will the option’s price.  It is merely a cosmetic change.

In trading, Long-term Equity Anticipation Securities can provide several advantages over short-term options.  For example, when protecting a stock holding through the use of puts, the investor can purchase the options and not worry about adjusting the position for up to 2½ years—which means less in commissions.  At the same time, bullish trades such as long calls and bull call spreads can be established using out-of-the-money LEAPS.  Doing so can provide the investor a long-term operating framework similar to the traditional buy-and-hold stock investor; but without committing as much trading capital to the investment.

Another difference between long-term and short-term options will be the impact of time decay, which refers to the fact that options lose value as time passes and as expiration approaches.  It is not linear, however.  Instead, time decay becomes greater as the option’s expiration approaches.  Therefore, all else being equal, 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-rewards when implementing strategies that require holding long-term options, such as calendar spreads or debit spreads, but not strategies that attempt to benefit from impact of time decay—like the covered call.


Frederic Ruffy
Senior Writer & Index Strategist
Optionetics.com ~ Your Options Education Site
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