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LEAP Option Investing
The Smart Profits Report: Issue #223
Friday, July 8, 2005
LEAP Option Investing: The Best Options Play on eBay
By Karim Rahemtulla
Chairman, Mt. Vernon Research
One of the reasons I love LEAP option investing is their ability to withstand severe shocks to the underlying stock - and still have upside potential.
With short-term options, you are often sunk unless the trade goes your way. Any unexpected news, earnings disappointments, competitive threats, etc., could turn a once promising investment into a loss in no time flat.
I have seen it time and time again… A company is sailing along and everyone is making money. The stockholders are happy and so are the options holders. In fact, there’s nothing but good times ahead. Then, out of the blue… news hits that is detrimental to the company’s prospects over the short term. The shares sell off only to recover within a few weeks or months as the information is processed and investors return to their senses.
Google, eBay, PayPal… And How to Maximize Your Returns
A good example is the recent news that Google would launch an online payment system. Immediately, shares of eBay, which owns PayPal, sold off sharply. Investors reasoned that Google would pose a nasty threat.
There was no attention paid to how big PayPal was, or how long it would take for this beta test from Google to become reality.
When all the facts are out, investors may realize that they sold eBay a little too quickly and without thinking through the ramifications - including the fact that the market is so large, competition may not be such a bad thing to attract new users.
Anyway, I will save that story for another day.
Short-Term Players Are Toast But Not The LEAP Option Investor
What is important is that investors holding short-term eBay options are basically toast. Chances of eBay recovering its losses in a week or even a month are not very good in this low-volatility market…
Especially when the legions of nervous and jittery short-term traders out there remain inclined toward bailing.
However, if you were a LEAP option investor holding an option that had a year or two left before expiration, the downward move in eBay options, while painful, might not be the final word.
After all, a stock like eBay, which can fall 20% in a week, can also rise 20% in a week. The 52-week range between high and low is almost $30 - that is a lot of room for growth in share price if the company performs and regains favor. In this fickle market, anything is possible.
So, the LEAPS investor is still in the game, while the short-term player is out.
Why Using LEAPS Also Beats Stocks
Not only that, but the LEAP option investor has a critical advantage over the shareholder, too, since the LEAP investor most likely invested 5% to 10% of what the stockholder has at risk. While eBay fell $4 the week of the Google announcement, the LEAPS may have fallen $1 or $1.50, depending on the strike price and expiration.
On a 1,000-share position, that would be a $1,000-$1,500 loss, versus a $4,000 one.
If you are investing in a stock with an outlook of only one or two years, then you should consider using LEAPS. If you don’t use LEAPS, then you are investing 90% more than you have to, and you are risking 90% more than you really should.
Good trading,
Karim
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Today’s Smart Profits Cribsheet
- Check out the Smart Profits Glossary for definitions of terms like “LEAPS” or “expiration” found in today’s article.
- For more on LEAPS check out Smart Profits #159, LEAPS Call Option: How to “Swap” LEAPS Call Options For 300% Returns.
Related Articles:
- LEAP Options: The Intel Bargain & A Potential 566% Return
- Option Trading Strategies - Option Plays That “Earn” Their Keep
- Option Position Sizing - How Much to Invest In Each Option Trade
