LEAPS Options
The Smart Profits Report: Issue #125
Wednesday, July 14, 2004
LEAPS Options: Making 30% While Others Make 3% On the SAME Stock
By Karim Rahemtulla
Investment Director, Mt. Vernon Research
In my opinion, anybody would be nuts not to trade LEAPS options as proxies for stocks when these unique options are available.
- LEAPS options - Long-term Equity AnticiPation Securities - are options that expire a year or more from your date of purchase.
- LEAPS options cost you 10 to 15% of the underlying share price and give you just as much chance to profit - even more of a chance, on a percentage basis. Plus, they limit your potential loss.
Too Much Money At Risk? Use LEAPS Options
Unless you are planning on holding the shares for more than a year or two, I believe you are putting too much money at risk in the current market buying large blocks of shares.
Why spend $50,000 on 1,000 shares of Merck when you can buy LEAPS options at the same strike price and control just as many shares for two years - for a mere $6,000?
Worst case: Even with a 25% stop loss on the shares, you’d lose more than twice as much on the stock if it went the wrong way and hit your stop loss. If you think Merck will return you 30% or more in two years, then LEAPS options are your best bet.
Now for another twist on the LEAPS story… One that’ll surely help you to increased options profits in coming days…
Scoring Without “Going All the Way”
The S&P stock index has gone up only 21% in two years, and practically nothing in the last six months. But you have a much better chance of making gains in this market with LEAPS.
If you think your stock is going up 30%, that’s a pretty ambitious move in a market like this.
But your stock doesn’t even have to reach your target 30% gain to make you that much and more with LEAPS options. You only need the share price to move in the right direction for a few days or weeks to clean up.
Let me give you a couple of examples…
Some Real-Life Examples of LEAPS Options as Proxies
A few months ago, through my LEAPS service, we bought LEAPS options as proxies on General Electric. The shares were at $30 and we bought the $32.50 LEAPS. Within three days, the shares moved to $30.90 - a whopping 3%.
However, we cashed out of our LEAPS options for a 30% gain in three days.
Why did the LEAPS move up so much with such a small move in the share price? The answer lies in the time-value component of the options-pricing model.
It goes something like this: If the stock can move up 3% in three days, it can keep climbing at that pace for a couple of weeks. And if it does, it could rise to, say, $33 or $34, and the LEAPS options would then be worth more.
That’s because the market, if it senses such a surge in the stock price, re-prices the option accordingly. Thus, the more time left until the option expires, the more it will cost… and the more you will get for it when you sell.
Not An Isolated LEAP Of Faith
A few weeks later, we did the same thing with a defense stock. The underlying shares moved up about 4%, and we made 36% in less than a week.
In both cases, the shares did not even approach the strike price on our LEAPS options, yet the options made us a ton of money.
My point is: When you use the right type of option and the right system, you can dwarf the returns from the stock market well before the stock reaches your target.
Good Trading,
Karim Rahemtulla
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Today’s Smart Profits Crib Sheet
- Today we talked a good deal about LEAPS options. For more on this strategy, check out Smart Profits #177, LEAP Options: The Intel Bargain & A Potential 566% Return.
- Check out the Smart Profits Glossary for detailed explanations of options-trading terms such as “LEAPS,” “strike price,” and “time value,” found in today’s article.
Related Articles:
- LEAPS Call Option: How to “Swap” LEAPS Call Options For 300% Returns
- LEAP Option Investing: The Best Options Play on eBay
- Option Losses: How to Grow Rich From Your Options Losses
