Options are typically used by shorter term traders as a way to leverage their capital on a volatile move in the underlying stock. LEAPS differ in that they are significantly longer term plays, generally with the intention of exercising the contract for shares once the contract is deep ITM.
LEAPS (Longterm Equity Anticipation Securities) have at least 1 year until expiration. Long term traders looking to make a directional bet in a stock utilize LEAPS to avoid time decay.
Let’s focus on the 170 call strike for both 5/6/22 (9 DTE) and 6/16/23 (414 DTE). The theta on the 5/6/22 170 call estimates a $23 decay, over 13% of the contract’s current value. The theta on the 6/16/23 170 call estimates a minuscule $3 decay, less than a 10th of 1% of the contract’s current value.
The second benefit to LEAPS is the vega. The vega on the 5/6/22 170 call estimates an $8 increase in the contracts value on a 1% increase in volatility. The vega on the 6/16/23 170 call estimates a substantial $68 increase in the contracts value on a 1% increase in volatility.
If you’re anticipating a longer term trend with volatility spikes, LEAPS could provide a lucrative opportunity. However, the one glaring downside to LEAPS is the cost. Because there is over a year of time until expiration, LEAPS have an abnormally high amount of extrinsic value.
The best time to play LEAPS is in a trending market with a lack of volatile catalysts looming over the market, such as inflation concern and conflict that disrupts the global economy.
From 2018 - 2021, MSFT averaged 44% annual growth. We can use this average annual growth to hypothesize a 44% growth over the next 12 months.
With the current underlying price of an MSFT share at $289 on 4/28/22, Let’s say we were to purchase 5/6/23 $320 call LEAPS in MSFT at $25.90.
Let’s plug this contract into an option profit calculator to see what our potential profit would look like in the contract.
If our projected 44% annual growth in MSFT is reached in the next year, we can anticipate roughly 279% growth on our LEAP contract for a total of $7,232.
This perfectly illustrates why many long term traders prefer LEAPS over shares. The profit on our LEAPS contract would exceed the profit on holding shares for a year by 235%.
As always, there is inherently more risk associated with the enhanced reward. If MSFT breaks its multi-year trend, we stand to lose substantially more than we would trading shares. Any LEAPS trade you may be looking into should be backed by substantial research due to the amount of capital being risked.