Long-Term Equity Anticipation Securities - LEAPS

LEAPs are "long-dated options." We're talking about any call or put options that last for many months (or even years) rather than having an exercise date that comes up in a month or two.

Hint: if you see an option with a date that is at least nine months away, you're dealing with a LEAP.

Just like any option, you can trade this option, and if the value of the underlying stock goes up or down, you can make money from the option. LEAPs are often used by people who own stocks and who want to make money without selling the stocks themselves. LEAPs can also be a way to start investing if you want to trade in options without buying stocks.

Example:

Weird Uncle Fester always had a thing for light bulbs. Then he died and left you his fortune, which amounts to 10 million shares of GE. You are very happy being worth a few hundred million dollars and just don't want to lose that money. But if you sell the shares, you will pay a tax because the IRS views that process as a "constructive sale." But you would likely be able to construct a LEAP which hedges your position and allows you to play golf all day and quit the burger flipping gig you used to have.

Think of leaps...of options. Not of faith. Although a commitment to the latter…helps. LEAPs are put or call options that go on for a very long time, like 10 months or 2 years or more.

Why the difference versus a normal put or call? Well, most normal puts and calls are priced, at most, about 6 months out.

Banks (who make markets in options)( like to be liquid. Should the market swing violently, even if they lose, they want to know how much they’ve lost within a relatively short time period. So LEAPs take on a different life with vastly different durations, or time, or theta.

You can imagine yourself as an investor in a 100 times revenue super-fast growth internet-something-whizbang company. You’ve made 200 million bucks in your investment, more dough than you ever dreamed you’d need. Definitely worth a pile-of-cash-selfie.

So all you really care about now is locking in gains and not being stupid in case this really is the next Google. So you would really like to sell, but you are waiting to move from a blue state to a red state and save 1-sixth of your gains.

So you want to wait to sell, but are nervous in the interim two years that your shares in FacePage will plummet from $250 a share to $20. And then you have to go back to work.

This is where LEAPs come in. You want to buy a 2-year LEAP that protects you from the huge downside. You do the math: At $100 a share, you still don’t need to go to work ever again.

You may only be able to afford a Winnebago, but you’ll survive without relying on ramen noodles for sustenance. So what do you do? You get a quote from an investment bank who trades in your stock and learn that, for $10 a share, you can lock in your $100 a share price for 2 years.

That is, you’ll net $90 a share because you’re paying that $10 today. And that’ll just have to do. Besides, not having to work, uh...leaves you plenty more time to take selfies...