How and when to use LEAPS stock options

Let’s say you are a long-term investor looking to reap rewards passively or have a strong belief in a stock’s long-term price movement. If so, LEAPS (Long-term Equity AnticiPation Securities) options may be for you. LEAPS options contracts are not always available for every stock in every stock sector. If you are familiar with stock options trading, you can apply the same strategies with LEAPS. LEAPS are long-term options with expiration of at least one year.

Filter out the noise

While short-term price movements may be too noisy, most investors firmly believe in the long-term direction of stocks. Day traders try to take advantage of short-term price fluctuations, but investors want to take advantage of larger swings spread over a longer period. This is where LEAPS comes in for investors.

Maximize percentage gains with leverage

Let’s take an example of using the social media platform Snap Inc. NYSE: SNAP, which trades at $16.20. If you spent $900 on SNAP, you would have 55 shares. The SNAP LEAPS call option with a strike price of $20 expiring in 12 months costs $3.

You can buy three contracts for $900. If SNAP rose to $25, XYZ stock would earn $8.80 per share on 62 shares for $484 for a profit of 54%. However, the LEAPS option would be worth $5 per contract on three contracts for a $1,500 profit on a $900 investment for a 160% return on investment. You would receive more than three times the return for the same principal amount.

On the other hand, if SNAP remained unchanged at $16.20 after 12 months, your 55-share investment in SNAP would still be worth $900, if you purchased LEAPS. They would expire worthless, leaving you with a loss of $900. The stock would have to rise 41% to break even during LEAPS, meaning it would rise to $22.90 from $16.20. This is a large underlying price movement needed to break even on the trade. However, why not put the odds in your favor?

Collect great rental rewards

In a previous article, we looked at how to collect rent on your stock holdings by writing covered calls. You can increase your rent premiums with LEAP options. In the same example with SNAP, you can buy the stock and sell the LEAP covered call instead of buying a LEAPS directional call option. This assumes you have the capital. If you bought 100 shares of SNAP at $16.20, it would cost you $1,620. If you sold the $20 LEAPS call option for $2.90, it would give you a premium of $2.90.

If XYZ were to rise 41.6% to $22.94, you would also make a profit of $3.80 after being called at the $20 strike price. This would result in a total profit of $2.90 premium and $3.80 of price appreciation for $6.70 or $670 for a 41% return. It may not be as much of a return as buying stocks and holding or buying calls, but there is also downside protection of the $2.90 premium. If XYZ remained at $16.20 after 12 months, you would still earn 18% just for the premium. If the price of SNAP fell, you would be covered at $13.30 to break even.

In the covered call scenario, you would get a maximum profit of $41.60 or a minimum profit of 18% if SNAP remains unchanged.

In the stock purchase scenario, you would gain 55% going to $25.00 or 0% if SNAP remains unchanged.

In the long LEAPS call scenario, you would gain 150% if you move to $25.00 or lose 100% if SNAP does not rise 41.6% to at least $22.90.

Applying multiple strategies with LEAPS

LEAPS are just options with much longer expiration dates. You can use most options strategies with LEAPS.

However, it is crucial to understand that the rewards are significantly high, mainly due to theta (time erosion). If you are playing directional trades, you will pay a large premium for time decay. It’s worth being aware of the Geeks options before entering LEAPS. It is possible to play straddle, but you need to take into account the prizes. As a general rule, don’t expect stocks to rise more than the benchmark indices. In these cases, collecting premiums and writing Covered Calls may be more profitable, selling puts or debt spreads.

Speculative scenarios for directional JUMPS

LEAPS can be used for speculation in certain scenarios for risk-tolerant investors if a stock drops on its earnings report due to a temporary catalyst such as an inventory glut or a backlog while migrating to a subscription model. When a company lowers near-term guidance but raises annual guidance, it could indicate that large orders have been pushed to later quarters rather than a demand shock.

This implies a temporary hiccup in its activities and could be played for a long-term recovery. It is also useful to identify chart patterns on larger time frames, such as weekly and monthly candlestick charts versus intraday time frames.

Before you consider Snap, you’ll want to hear this.

MarketBeat tracks Wall Street’s highest-rated and best-performing research analysts and the stocks they recommend to their clients on a daily basis. MarketBeat identified the five stocks that top analysts are quietly whispering to their clients to buy now before the broader market takes hold… and Snap wasn’t on the list.

While Snap currently has a “Hold” rating among analysts, top analysts believe these five stocks are better buys.

View the five stocks here