Definition
LEAPS Options, or Long-term Equity Anticipation Securities, are publicly traded options contracts with expiration dates that are longer than one year. They give the option holder the right to buy or sell a company’s stock at a specified price before the option’s expiration date. They are often used for long-term hedging or investment strategies.
Key Takeaways
- LEAPS Options, standing for Long-Term Equity Anticipation Securities, are publicly traded options contracts with expiration dates that are longer than one year, allowing long-term investors to gain exposure to prolonged price changes.
- Investors often use LEAPS Options instead of buying stocks directly because they require less capital investment. A key advantage is that they leverage the potential return, although they could be considered more risky as investors can lose the entire initial investment if the stock price does not move in the expected direction before expiration.
- LEAPS Options provide a way to hedge a long-term investment over a longer time horizon than standard options. They are beneficial to investors to limit short-term risk, and for companies, they result in less market volatility in their stock.
Importance
Long-term Equity Anticipation Securities (LEAPS) options are significant in finance as they provide investors a longer-term investment strategy due to their extended expiration dates, typically lasting up to two years or more.
This extended expiry date gives an investor the right, but not the obligation, to buy or sell an asset at a predetermined price within a specified time frame.
With the potential for high returns, LEAPS options can offer an affordable way to control a larger number of shares, allowing investors to leverage their positions without the need for large upfront capital.
Additionally, they provide an effective method to hedge against potential downturns in the share price of a company over a longer period, thus making them a crucial tool for risk management.
Explanation
Long-term Equity Anticipation Securities (LEAPS) Options are a type of option used by investors mainly for long-term investment strategies. Their purpose is to give an investor the right, but not the obligation, to buy or sell an asset at an agreed-upon price during a specific period, which is often up to three years.
LEAPS options provide investors an opportunity to be exposed to a longer duration of time, which ultimately offers the benefit of having ample time for their bet on the markets or individual stocks to play out. Investors typically use LEAPS options for a variety of strategic reasons.
For instance, they offer a cost-effective way to control a larger amount of shares with the leverage that options provide. Investors can mimic the profits of a stock ownership without actually owning the stock, avoiding the large capital outlay that comes with it.
This makes them an attractive choice to investors who wish to hedge their stock investments for a longer time period or to speculate on the long-term price movements of stocks. Overall, they aim to provide enhanced flexibility and scope for making a considerable return on investment while limiting potential loss.
Examples of LEAPS Options
Investing in Long-term Tech Stocks: An investor anticipates that the stock price of a tech company, such as Apple or Microsoft, will increase significantly within the next couple of years. However, the investor may not have enough capital to buy numerous expensive shares outright. Instead, they could buy a LEAPS call option, giving them the right to purchase the stock at a specified price (strike price) before the option expires. If the stock price rises as expected, they can exercise the option and buy shares at a lower price, making substantial profit.
Hedging Long-term Investments: A shareholder in Amazon has profited from a significant increase in the company’s stock price over the years. However, the investor is concerned about potential long-term risks that might adversely affect the stock’s price. To protect their investment, the shareholder could buy a LEAPS put option, giving them the right to sell the shares at a predetermined price. If the stock price plummets below the strike price, the shareholder can exercise the option and sell the shares at a higher price, thereby limiting losses.
Speculating on Commodity Markets: An investor believes that crude oil prices will significantly decrease in two years due to expected technological advancements in the renewable energy sector. However, investing directly into the volatile commodity market can be risky. Instead of betting on the oil prices directly, the investor could buy a LEAPS put option on an oil company’s stock like Exxon or Chevron. If the oil prices decline and subsequently lead to a decrease in the oil company’s stock, the investor can exercise the LEAPS option and profit from the stock’s decrease.
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FAQs on LEAPS Options
What are LEAPS Options?
Long-term Equity Anticipation Securities (LEAPS) are publically traded options contracts with expiration dates that are longer than one year. LEAPS are no different than short-term options, but the longer duration offered through LEAPS provides investors the opportunity for long-term investments.
What are the Benefits of LEAPS Options?
LEAPS options provide the ability to gain exposure to a long period of time, allowing for the investor to take advantage of long term trends and forecast. Additionally, LEAPS options can be less expensive than purchasing a comparable amount of the underlying equity.
What are the Risks Associated with LEAPS Options?
LEAPS can expire worthless. This occurs when the underlying asset’s price is lower than the strike price by the expiration date. Additionally, the longer lifespan of a LEAPS contract can also mean higher premium costs.
How are LEAPS Options Different From Other Options?
The primary difference between LEAPS options and other options is the expiration dates. Most options have an expiration date of one year or less. LEAPS options typically have an expiration date of up to three years in the future.
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Related Entrepreneurship Terms
- Long-Term Equity Anticipation Securities: The full form of LEAPS, denote options that have a longer time to expiry than ordinary options, generally over a year.
- Derivative Instruments: Instruments such as options or futures, whose value is derived from an underlying asset. LEAPS options are an example of derivative instruments.
- Exercise Price: Also known as the strike price, it’s a fixed price at which the owner of an option can buy or sell the underlying security or commodity.
- Time Decay: Refers to the decreasing value of an options contract as its expiration date approaches. However, LEAPS options resist time decay longer due to their longer expiration period.
- Implied Volatility: A metric that reflects how the market expects the price of the underlying asset to change. This is a significant factor in the pricing of options, including LEAPS.
Sources for More Information
- Investopedia: This site provides a vast array of financial and investing knowledge including well-detailed information on LEAPS Options.
- Chicago Board Options Exchange (CBOE): CBOE is where LEAPS Options were first introduced. The site is a vast repository of knowledge about options.
- Options Playbook: This resource offers simple, easy-to-understand information suited to a wide variety of investors, making it perfect to understand LEAPS options.
- Charles Schwab: This globally recognized brokerage house provides comprehensive finance and investment related articles and tools.
