By: Marty Kearney

Senior Staff Instructor, The Options Institute, CBOE

There are numerous advantages to trading long-term instruments like LEAPS, including a wider time frame for the desired price action to develop and decreased impact of time decay.

(The following is an excerpt from Marty Kearneys book, Leaps Trading Strategies . )

Why would you trade long-term instruments (LEAPS) when you could trade shorter-term, lower-priced options? The answer is a good one: That longer termup to three years compared to only a few monthsmakes so many option and LEAPS strategies more practical and more effective.

As you can see in Figure 2.1 below, the time decay of long-term equity anticipation securities (LEAPS) is substantially different from short-term options. All of the US exchanges have approved the slope of LEAPS time decay. Approval has also been granted by the compliance department of the Options Industry Council (OIC). A few years ago, a particular LEAPS contract did not show dramatic movement in time decay in those first couple of years, and the line had to be altered. The slope had to be made much more dramatic. But the idea here is that options do not decay in a linear manner.

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If a one-month option is trading at one, the four-month option is not trading at four. There is a lot of variation, and you have to expect it. The volatility of the underlying stock is going to affect how time value falls. In fact, you could separate out the pure, rather predictable time element, and then view the variations as a volatility premium. That is usually called extrinsic value, to distinguish the price movement patterns from pure time value.

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Heres an anecdote about how options work. One of our Options Institute instructors was in an elevator a few years ago, taking some friends out to lunch. In the back of the elevator were a few people from our compliance department, who have to approve everything we put together and talk about to the public.

How did our instructor know thats who they were? Well, because they were wearing the pencil protectors on their shirts, a sure sign. And I dont mean that as an affront to anyone; its simply the truth.

The instructor decides to have a little fun with these compliance folks, so he says to them, Listen, were thinking of doing a new seminar pretty soon. The compliance people looked at each other and one asked, Well, can you send us the material? Well carve it up and make the changes and additions and deletions that are required.

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