What are Long-Term Equity Anticipation Securities (LEAPS)?
Long-term equity anticipation securities (LEAPS) are publicly traded options contracts with expiration dates that are longer than one year. Structurally, LEAPS are no different than short-term options, but the later expiration dates offer the opportunity for long-term investors to gain exposure to prolonged price changes without needing to use a combination of shorter-term option contracts. The premiums for LEAPs are higher than for standard options in the same stock because the further out expiration date gives the underlying asset more time to make a substantial move and for the investor to make a healthy profit.
Understanding Long-Term Equity Anticipation Securities (LEAPS)
Long-term equity anticipation securities are one way for a longer-term trader to gain exposure to a prolonged trend in a given security without having to roll several short-term contracts together. The ability to buy a call or a put option that expires one or two years in the future may be alluring to some traders because it gives the holder exposure to the long-term price movement without the need to invest the larger amount of capital that would be required to own the underlying asset outright. These long-term options can be purchased for individual stocks, as well as equity indexes such as the Standard & Poor's 500 Index (S&P 500).
- Long-term equity anticipation securities are ideal for option traders looking to trade a prolonged trend.
- LEAPS can be applied to a particular stock or an index as a whole.
- LEAPS are often used in hedging strategies and can be particularly effective for protecting retirement portfolios.
How Equity LEAPS Work
Equity LEAPS allow investors to gain exposure to a specified stock without having to own or short sell shares of the underlying stock. Stock LEAPS call options allow investors to benefit from potential rises in a specified stock while using less capital. Similar to short-term call options, LEAPS calls allow investors to exercise their options by purchasing the shares of the underlying stock at the strike price. Investors may sell the LEAPS calls at any time prior to expiration to realize their profit or loss.
LEAPS puts provide investors with a long-term hedge if they own the underlying stock. Additionally, LEAPS puts may be used to speculate on a potential fall in the underlying stock. For example, consider an investor who has long shares of XYZ Inc. and wishes to hold them for a long period of time, but is afraid the stock may fall prior to that. The investor could purchase LEAPS puts on XYZ to hedge against unfavorable moves in the long stock position.
How Index LEAPS Work
Index LEAPS allow investors to hedge and invest in indices tracking the entire stock market or specified industry sectors. Index LEAPS allow investors to take a bullish stance using call options or a bearish stance using put options. Investors could also hedge their portfolios against adverse market moves with index LEAPS puts. For example, assume an investor holds a portfolio of securities, which primarily includes S&P 500 constituents. The investor believes there may be a market correction within the next two years, and therefore, the investor purchases index LEAPS puts on the S&P 500 Index to hedge against adverse moves. If the index falls, the stock holdings in the portfolio will likely fall, but the LEAPS put will increase in value helping to offset the loss in the portfolio.