Leap Options: What Are They? Pros & Cons
The term “LEAPS” in LEAPS options is actually an acronym, which stands for “Long-term Equity Anticipation Securities.” LEAPS options are long-term options that have an expiration period between one and three years, versus less than a year for standard options.
LEAPS (sometimes called leap options) are derivatives contracts traded on exchanges, and allow investors to utilize less capital than if they were purchasing the underlying asset outright.
Other than the longer-than-normal expiration date, leap options are functionally much like other types of options — they’re contracts that grant the buyer the right to buy or sell an underlying asset at a specific price before its expiration date.
LEAPS Options Defined
Puts, calls, bulls, and bears. For the uninitiated, options terminology offers a steep learning curve. Even those who are familiar with options trading can occasionally find themselves in the weeds, as there are myriad option types and derivatives to keep track of.
LEAPS or leap options are a variation on the basic options contract, and these longer-term instruments may become part of your strategies for trading options.
LEAPS come in two basic flavors: call options and put options. And like shorter-term options, traders pay a premium when buying LEAPS options. Further, LEAPS can be tied to individual stocks or ETFs, as well as market indexes and other types of securities.
Recommended: Options Trading 101
How to Buy LEAPS Options?
Buying LEAPS options is pretty straightforward, assuming you’ve been investing for a bit. Typically, all that’s required is a brokerage account with access to options trading — and that’s something that many, if not most brokerages offer investors.
The process for actually executing a LEAPS option trade will depend on the specific brokerage you use, but it’ll generally involve choosing a put or call option, a strike price, and critically, a long-term expiration date.
Remember, LEAPS options expire more than a year from when they’re purchased, so opting for the longer-term expiration date will differentiate a LEAPS option from a standard option purchase. This may be helpful when considering long-term vs. short-term strategies.
Finally, user-friendly options trading is here.*
Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.
*Check out the OCC Options Disclosure Document.
What Are the Pros & Cons of LEAPS Options?
Like trading other types of options, there are some upsides and downsides to trading and investing with LEAPS options:
What Are the Pros of LEAPS Options?
A big upside to LEAPS is that they have a longer time frame compared to standard options. Thus, they experience less time decay, and theoretically, their values should move more closely with the price movements of the underlying asset.
A less recognized advantage of the longer time frame is that — unlike options that may expire in months, weeks, or even days — the need to constantly oversee the markets and to take advantage of short-term moves is lessened.
LEAPS also tend to cost less than their underlying asset, making them an attractive alternative for some investors.
But perhaps the biggest advantage to LEAPS is they can provide outsized returns, despite the attendant risks, which is what attracts some traders to them in the first place.
What Are the Cons of LEAPS Options?
On the other side of the coin, investors should know that LEAPS can have higher premiums than standard options due to the much higher time value of LEAPS while still remaining cheaper than the underlying asset.
Buying LEAPS, you’ll need to put more money upfront than if you were to purchase shorter term options, risking more of your capital.
LEAPS are also not available for every stock, industry, or index out there (index investing is a separate strategy, but some options are tied to indexes). So, you may not be able to find what you want.
Plus, if you decide to purchase LEAPS options, you could also magnify your losses (just as you can increase your gains), which is something that’s critical to keep in mind. In other words, there are additional risks when investing with LEAPS.
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LEAPS Options: Pros and Cons |
|
|---|---|
| Pros | Cons |
| Potentially magnify investing gains | Potentially increase investing losses |
| Costs less than the underlying asset | Higher premiums vs. standard options |
| Value mirrors underlying asset more closely | LEAPS may not be available for all assets |
Explaining LEAPS Options Trading
How does LEAPS options trading actually work?
Let’s run through an example, and note that trading LEAPS is the same as trading options, but with longer expiration periods:
If you were of the belief that a certain stock, we’ll call it Stock XYZ, was going to experience a decline in value at some point in the next few years, you could use LEAPS options to position yourself accordingly. Specifically, you’d look at buying a LEAPS put option on XYZ with a long-term expiration date.
XYZ is trading at around $55, but again, you think that it will fall. As such, you pay $7.50 for a $45 put that matures more than a year from now.
If XYZ drops in price, you can expect the put to increase in value and you may sell for a profit as you see fit.
OR
You can wait for the XYZ to drop below $37.50 (your break even point = $45 – $7.50 = $37.50) and exercise your option or sell the option. Based on time to expiration and multiple other factors, you can decide which choice is more profitable.
Recommended: Long-term Investing Strategies
What Are Some Helpful LEAPS Options Strategies?
There are many different strategies for trading options, and many can be applied to trading LEAPS. And since options strategies can quickly get complicated, it may be best to keep it simple.
As such, one basic LEAPS options trading strategy is to buy calls, and try to benefit from a potential increase in value of the underlying asset over the course of a year or two.
LEAPS can almost stand in for the underlying asset itself, and offer a couple of key advantages: They can increase returns by allowing you control over more shares for less capital, and minimizing your potential losses to the cost of the option’s premium.
Active investors can use LEAPS to benefit from short and long-term market activity. If, for instance, you thought that XYZ was going to experience a stock value decline over the next year, but suspect that it may bounce back and increase in value over two or three years’ time.
You could buy a three-year put LEAPS call option, in that case, along with a standard put option. That would allow you to potentially benefit in the short and long-term in regards to Stock X.
Invest in LEAPS Options with SoFi
The chief difference between LEAPS options and other types of options is that they have longer-than-normal expiration periods of one to three years versus less than a year for traditional options.
Other than that, LEAPS are similar to other types of options in that they’re derivative contracts that grant the buyer the right to buy (call options) or sell (put options) an underlying asset at a specific price before its expiration date.
Trading options is complicated, and can be quite risky, there’s no way around it. For some investors, it may be best to stick to the basics — invest for the long term, and build a portfolio with stocks and ETFs. But once your bases are covered, options can be a next step in your investing evolution.
If you’re ready to try your hand at online options trading, SoFi can help. You can trade options from the SoFi mobile app or through the web platform. And if you have any questions, SoFi offers educational resources about options to learn more.
Photo credit: iStock/dusanpetkovic
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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