How Does LEAPS Works And How I Use LEAPS To Maximise Gains?

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).

LEAPS Matrix
When using LEAPS, there are a few matrices that influence my decision. They are explained as follow:

Delta is the amount an option price is expected to move based on a $1 change in the underlying stock. Delta ranges from 0 to 1. For example, for a delta of 0.50, it means that the option premium is expected to rise or fall $0.50 respectively for each $1 movement of the share price. Ideally, we want a higher delta (in a bullish market) because it will mean that there are more gains when the share price moves upwards. Having said that, the opposite holds true as a high delta will mean more money lost on the premium when the share price falls. Delta also affects the premium price. The higher the delta, the higher the premium price.

Delta also measures the probability that the strike price will be hit on the expiration date. Thus, lower delta = lower probability. However, I am not too bothered by that. I will explain that later in this article.

Premium Price
Buying a LEAP is like buying a CALL option with a long expiration date, so you will need to pay a premium to own a CALL contract. I like to keep my LEAPS premium to 10% of the current share price, which I feel is the sweet spot to get a good return if the share price rises. Premium price is affected by Delta (as explained above) as well as date of expiration. The further the date of expiration, the higher the premium required for the same delta.

Date of Expiration
The date of expiration refers to the date that the contract officially ends. Ideally, we want the date or expiration to be as far our as possible, say 2 years. This is to allow the shares (of a fundamentally strong company) to grow as high as possible so you can cash in your LEAPS contract (by selling) before it expires. However, a longer expiration date will translate to a higher premium, which is a trade-off. The shorter the date of expiration, the cheaper the LEAPS options but there is also a risk of short-term price volatility which increases the risk of the LEAPS contract expiring worthless.

LEAPS Growth Formula
I created a formula to calculate the expected growth that a LEAP contract can bring, using current share price, premium price and delta. The formula is as follow:

Expected Growth = Delta / (premium price / current share price)

You can use a simple formula to help you display the results in an excel spreadsheet.

Example: Apple LEAPS

Current share price: $150
Premium: $15
Delta: 0.50

Expected Growth = 0.5 / (15/ 150) = 0.5 / 0.1 = 5

This means that whenever apple increases by 10% in share price, your LEAPS premium will increase by 50% in premium price.

How is that possible?

Say Apple increases by 10% in share price, which is $15, so using delta of 0.5, the premium should increase by $7.50.

If you take $7.50 / $15.00, it is a 50% increase in premium price.

LEAPS Strategy

Strategy 1: Use LEAPS in a bull market to magnify returns
I have used LEAPS to good effect in the recent bull run after Q2 earning in August 2021. The run-up of big tech and semiconductor stocks means that I get to magnify the returns using LEAPS.

Strategy 2: Earn when the current share price rises above your purchase price
Many people are mistaken that by using LEAPS, you will only earn money when you hit the strike price, which is a low probability if delta is low. That is totally wrong! You earn money when the price of share moves above your purchased price, and your premium increases. Then, you can sell off the contract and earn the profits of premium increase.

See this article to explain more:
I Was Laughed At When I Told Them I Bought LEAPS With A Low Delta

Strategy 3: Buy LEAPS with low delta
I usually buy LEAPS with lower delta so that I can
1) buy LEAPS for tech giants like Alphabet which has a huge share price
2) buy more LEAPS contracts with the same amount of capital
3) I can have the flexibility of selling them as and when I like, especially when I am taking profits in a bull run. If I only have one big LEAP contract, I may sell at the wrong time when the stock is still rising. It is like owning 5 shares vs owning 1 share (but using the same capital).
4) Safeguard against downwards trend when stock price plunges as lower delta means premium drops at a lower rate

You can read more about Strategy 3 in this article:
Why I Buy LEAPS With A Low Delta?

Strategy 4: Buy LEAPS at a longer expiration date (1.5 years or more)
This allows me more time to stomach the price volatility and more time to allow the share price to grow and maximise my profits. Good companies tend to grow in value and share price over time so LEAPS options are a good way to capitalise on that. Having said that, I sometimes buy shorter-term LEAPS to capitalise on the uptrend so as to earn more short-term profits.

Strategy 5: Average down my LEAPS when market turns bearish
When the preimum of my LEAPS falls significantly due to a downward trend/ market correction and I have the conviction that the stock price will rise eventually, I will buy the same contract at a lower premium to average down the cost for that particular LEAP option contract (with same expiration date and strike price).

I hope this article is useful to you in understanding how LEAPS work, the potential returns you can get from using LEAPS for your shares as well as the strategies of deploying LEAPS to help you get a good profit and build wealth.

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2 thoughts on “How Does LEAPS Works And How I Use LEAPS To Maximise Gains?

  1. Hi Jason, please correct me if I am wrong about your LEAPS theory.

    Stock A is trading at current share price X.
    That same day I bought a LEAPS call, expiration date 21 Jan 2022, strike price is X+200.
    After a few months, Stock A share price went up to X+50.
    Is it true so long as the price is above X, whenever I choose to sell my LEAPS, it would be profit?


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