A LEAP (Long-term Equity Anticipation Product) is simply a long-dated option. LEAP options that don't expire upto 2 years into the future give the buyer much more time to be right about the future direction of a stock and at the same time offer tremedous leverage. LEAP option trading has become quite popular in recent years because just like all options, LEAPs only cost a fraction of what it would cost to buy shares in the underlying stock itself, but give you the same amount of control. As with all options though, time is the enemy (if you are a buyer) and over time options lose their value. So how can we use LEAPS to speculate on the future direction of a stock (UP or DOWN) and at the same time reduce our risk of losing all our money on them? Well let me share with you a couple of simple LEAP option trading strategies that have worked well for me over the years in both bull and bear markets. TIP: If you believe a stock will go UP over the next 1-2 years, then buy Call option LEAPs on it and at the same time sell the call options (at least one or two strike prices out of the money) that expire in the current month.
If you believe a stock will go DOWN over the next 1-2 years, then buy Put option LEAPs on it and at the same time sell the put options (at least one or two strike prices out of the money) that expire in the current month. By doing this you will effectively be getting cash back on your investment every single month that you hold your LEAPs. Over the long-term this will not only offset the time-decay of your LEAPs, but also offer you some downside protection, should the stock go in the opposite direction that you want it to.
This is known as a Calendar Spread and is a much more conservative way of speculating with LEAPs. Important: If the stock rises above your sold strike price for your current month Calls or below your sold strike price for your current month Puts, then you risk being assigned/exercised. You should never allow this to occur because the moment you are assigned you will lose whatever time value is left on your LEAPs.
It is far better to close out the trade for a profit by buying back the sold option and selling your LEAPs for an overall profit or simply holding your LEAPs and then writing (out of the money) options against them for the next month.
James Thomas is a successful private option trader and creator of http://www.option-trading-tips.blogspot.com - an informative resource full of useful option trading tips, including free video tutorials.