LEAPs are a type of option that stands for Long-term Equity Anticipation Securities. In practice LEAPS are simply vanilla equity options with an expiration date of more than one year.
While most equity options are set to expire in 3 months or less, with a smaller market for up to 6 months, LEAPS are an even rarer equity option that provide investors with long term exposure to price changes in the underlying asset.
The natural difference that makes LEAPS stand out from the more traditional variety is the much larger premiums that investors need to pay to purchase them for the same exposure between the current price and the strike price.
This is the term premium that option writers demand for the extended period that they are exposed to changes in the price of the underlying stock.
Since the longer an option on a stock is held the greater the probability that the stock will undergo substantial changes in price, the option writer must charge a larger premium to compensate for his increased exposure over a much longer period do time.
This is in contrast to short term options, where many traders are taking advantage of the flexibility that option contracts offer to make complex and sophisticated trades based on short term price movements in the associated stock.
Traders who purchase LEAPS are usually looking for a means of betting on the long term price of a stock without having to tie up a lot of capital in that stock directly.
The structure of equity options is such that investors can make out-sized bets without tying up much of their capital, which is ideal for long-term investing.
A secondary reason to buy LEAPS is when a trader is confident about the overall direction of a price movement, but less confident about the timing. Waiting too long can mean missing the event when it does happen or paying too high a premium once other traders become aware of the potential trade.
LEAPS allow traders to “set and forget” long term trades, confident that when the price does change their way, they will already be in a position to profit from it.
Final Thoughts on LEAPS
While the concept behind LEAPS is simple enough, they represent a different approach to option trading from the fast-paced and near-term trading that dominate the market for vanilla equity options.