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If you believe that the stock market will rise over the next couple of years, the traditional way to put your money behind that belief is by purchasing stocks — for example, index funds.
But for advanced traders, there is another way to speculate on long-term stock price movements, and it may be cheaper than buying the stocks themselves: Long-term equity anticipation securities, or LEAPS options.
What is a LEAPS option?
LEAPS are options with unusually long durations. While typical options expire in less than a year, LEAPS may expire up to 2 years and 8 months in the future.
Aside from their long lifespans, LEAPS work the same way as normal put options and call options. They track an underlying stock and have a strike price and expiration date. Some LEAPS track individual stocks, while others track indexes such as the S&P 500.
A LEAPS call buyer pays a small amount of money (a “premium”) for the right to buy the underlying stock or index at the strike price on or before the expiration date, and wants the market price to go above that strike price before expiration so that they can exercise or resell the option for a profit.
If you’re a LEAPS trader who thinks stocks are headed lower in the next couple of years, you’d probably buy LEAPS puts. A LEAPS put buyer pays a premium for the right to sell the underlying security on or before the expiration date, and wants the market price to go below the strike price before expiration.
Because of their long durations, LEAPS provide a way for investors to make big bets on stock price movements over the next few years, without needing to spend the money to buy an equivalent number of shares of the underlying stock.
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The pros and cons of LEAPS options
For experienced investors who have a lot of capital to trade with, LEAPS may provide certain advantages over ordinary stock trading:
May be cheaper than the underlying stock. An options contract typically controls 100 shares of the underlying stock, and many LEAPS contracts are currently a lot cheaper than the price of 100 shares.
Potential for higher returns. A successful LEAPS trade can potentially double or triple your money from a much smaller move in the underlying stock.
However, LEAPS aren’t for everyone — they may not be practical for smaller-balance or less-experienced investors. LEAPS have some distinct drawbacks compared to regular stock ownership:
Higher-risk than stock ownership. Like any other options trade, buying LEAPS comes with a risk of losing your entire investment if the market price of the underlying stock is below the strike price (for a call) or above the strike price (for a put) at the time of expiration. LEAPS are typically more expensive than short-term options.
Limited time horizon. One advantage to directly owning stocks is that they can yield many years of gains. LEAPS are longer-term than other options, but they still have a limited timeframe — you could miss out on any post-expiration-date gains in the underlying stock.
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