This article is for readers who already have knowledge on how options work, in particular LEAPS options. If you are a beginner in the investing world or relatively new to options trading, you may want to skip this article first and come back when you have grasped the concept of options trading.
LEAPS stands for Long-Term Equity Anticipation Securities, which basically refers to buying a CALL/ PUT option contract with a long expiration date, at least 6 months or more. Essentially, if you are buying a LEAPS CALL, the strategy is to watch the share price grow, which translates to an increase in the value of the premium, which you later sell off the contract to earn a profit (new premium price minus the premium price that you have paid).
I like to buy LEAPS on my favourite companies, especially those that are out of my budget to sell PUT contract, e.g. Alphabet (Parent company of Google and YouTube). At the current share price of $2.8k, I will need at least $280k as collateral if I wish to sell a PUT contract on Alphabet. The LEAPS brings an amazing ability to magnify returns for an invested amount and my biggest rewards in my trading journey so far comes from LEAPS.
Despite these advantages and potential high returns, LEAPS does have its disadvantages as it can be a double-edged sword. In a bull market, LEAPS can magnify returns but in a bear market, LEAPS can magnify your loss! As such, it offers less flexibility than the WHEEL strategy in generating consistent returns, especially when the market turns bearish or go sideways.
In today’s article, I wish to share a LEAPS contract that I bought on Alphabet. The contract details are as follow:
Strike Price: $3500
Expiration Date: 17 June 2022 (238 days from today, 21 Oct 21)
Bought at current price (21 Oct 21): $2848
Premium Paid: $47.85 per share or $4785 per contract
Delta is the amount an option price is expected to move based on a $1 change in the underlying stock. Thus, for a delta of 0.169, the option premium is expected to rise or fall $0.169 respectively for each $1 movement of the share price.
Let’s assume Alphabet shares rise by $200 in a month’s time.
The option premium is expected to rise by $200 x 0.169 = $33.80
A $200 increase in share price gives a return of 7% (200/ 2848) for shareholders who own Alphabet shares. However, a $33.80 (expected rise in premium based on delta value) increase in premium price gives a 70.6% returns in capital invested in the premium of this LEAPS contract. That is 10x higher in returns as compared to capital gain in share price.
The upside is unlimited, which means that if Alphabet rises by $1000 before contract expiration date, the returns become 353% and so on. I also realised that delta changes (proportionally) as share price increases.
It is important to note that if Alphabet drops by $1000 (IMO very unlikely), the contract will become almost worthless and the premium of the contract will drop significantly as well. The maximum loss is capped at the premium paid for the contract, which is $4785 (should share price plunge to $0).
To conclude, the returns for LEAPS options can be insanely high but they also come with a higher risk, especially if shares are plunging. Thus, please take extra precaution when using LEAPS and only use it on stable companies like the Big Tech or Semiconductor Giants. Using LEAPS on penny stocks, meme stocks or any speculative stocks may wipe out your entire investment, so be very careful about it. I hope this article provides you with good insight on LEAPS and helps you in your investment strategy.
To understand more about LEAPS, do read these articles:
How Does LEAPS Works And How I Use LEAPS To Maximise Gains?
Why I Buy LEAPS With A Low Delta?
I Was Laughed At When I Told Them I Bought LEAPS With A Low Delta
Understanding How CALL Option Works