Long-Term Equity Anticipation Securities – LEAPS 5.00 / 5 (100.00%) 1 vote

LEAPS, or Long Term Equity Anticipation Securities, are publicly traded option contracts that have expiration dates of up to 3 years, but a minimum of 1 year. LEAPS are structurally similar to other options save for their long term expiry dates. They offer investors with a longer time-horizon the opportunity to gain exposure to an extended trend in a particular asset. This is relatively easier than using a combination of shorter term option contracts to take advantage of a dominant trend. LEAPS are available on individual stocks as well as indices such as the S&P 500.

Long-Term Equity Anticipation Securities – LEAPS

How They Work

LEAPS give investors the right to buy a particular stock asset or index at a specific price any time before expiry. As a case, Google (GOOG) is currently trading at $500 a share and as an investor you have $50,000 to invest. By buying the stock the traditional way you will own 100 shares of the company. If you utilize the leverage of 2:1 offered when trading stocks the traditional way, you will own 200 shares of the company. If after, say 3 years, the price of Google is 700 you would earn a gross profit of $20,000 or $40,000 if you utilized the traditional stock leverage.

If, by LEAPS instead, you use your $50000 to buy 100 contracts of Google (each contract is the equivalent of 100 shares) at a strike price of $600, which gives you the exposure to 10,000 shares of Google. This way you earn the right to buy Google shares at $600 per share at any time before expiry and you pay $100 (600-500) per share for this right. After 3 years, when the option contract expires, you will earn a gross profit of $1,000,000 (10,000*100) if the price of Google is $700. Out of an investment of $50,000, you will have earned a profit of $950,000, despite price making an advancement of 40%.

The Benefits of LEAPS

Equity LEAPS offer longer term investors the opportunity to reap substantial monetary rewards from the growth of blue chip companies without necessarily buying their shares outright. In addition, investors can also use equity LEAPS to hedge against significant drops in their primary stocks.

Investors can also use index LEAPS when they expect the entire market to be either bullish or bearish. Index LEAPS also allow investors to invest in, trade or even hedge an entire market or industry for a longer term period.

The Risk of LEAPS

The structure of LEAPS ensures that the risk is defined and limited. Unless you are an uncovered buyer or seller of LEAPS calls or puts, your risk is limited to the price paid for the contract or position. In our earlier example, the maximum amount you can lose is $50,000, which is the price you paid for the contract whereas your profit potential is practically unlimited.