If done correctly, buying LEAPS can translate to a big gain over the course of a year, while the wrong LEAPS can cost you dearly.
Buying LEAPS is gaining popularity with investors focusing on long-term gains. The acronym LEAPS stands for long-term equity anticipation securities, so it is no surprise that the goal is to see returns over more extended periods.
Investors do need some insight to be profitable investing LEAPS. It’s essential to understand what LEAPS are, what to look for in them, how to invest, and to understand the type of investor that can get the most from LEAPS investing.
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Once considered a niche segment of the investing world, options trading has now gone mainstream.
With little knowledge on the best strategies, you can use options to work the odds in your favor and make trades that have up to an 80% probability of success. Find out how in this free report, How Options Work—and How to Hedge Portfolios with Options.Read Your Free Report Here.
Understanding LEAPS for better investment results
These long-term equity securities are exchange traded options that have a maturity period between one and three years. LEAPS options act no different than short-term options, and the more extended maturity period is the most significant difference. All options contracts involve a buyer and seller. LEAPS contracts allow the buyer the option to buy or sell the underlying asset at a specified price before or on its expiration date. The type of option determines whether it is a call or a put. A call option provides the right to buy while a put option provides the right to sell.
Some investors will say that participating in a LEAPS program is like renting stocks instead of owning them. They don’t pay as much as they would from purchasing the stocks outright, and investors have a chance at significantly larger gains if they accurately predict the stock’s direction.
As with other options, each contract is for 100 shares of the stock or underlying asset, and the strike is the agreed upon price of the asset. Once the option reaches maturity on the expiry date, the asset will convert to the agreed upon price.
Investors should focus on a few characteristics while avoiding others when they are buying LEAPS
LEAPS worth investing in are ones you can use to hedge a long-term holding, like a retirement portfolio. Targeting market segments, industries, or equity indexes is common. Some investors recommend starting with a LEAPS option that is already in-the-money by at least 20%.
It is also important to understand some reasons why investors avoid LEAPS. Unlike stock investing, LEAPS come with an expiration date. If an investor buys a LEAPS option that does not increase before the expiry date passes, the investment is lost. Similarly, if the underlying assets increase one day after the expiry date, the investment is still lost.
The more extended periods associated with LEAPS can be difficult for some investors to deal with, especially if they opt for a contract that is three years from the current date. It can be hard enough to determine the price direction for an asset over the span of three months, let alone three years. This uncertainty of knowing how the market will move can make it hard to get decent returns with long-term contracts.
Another big reason why some investors will invest in a stock directly as opposed to a LEAPS contract is the fact that LEAPS don’t pay dividends, unlike profitable stocks. Ultimately, investors who primarily target dividend income should avoid LEAPS.
Buying LEAPS can work for the right investors
Buying LEAPS can be done through brokers or online. Buying LEAPS can be seen as a conservative speculation strategy. Conservative investors historically will look at options as high-risk strategies, but since LEAPS are for longer periods, the level of risk is lower than with short-term options.
LEAPS can lead to significant gains, but they come with a lot of risk that can lead to complete losses. Choose wisely if you plan on buying LEAPS in the future.
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Nancy Zambell has spent 30 years educating and helping individual investors navigate the minefields of the financial industry. As a lecturer and educator, Nancy has led seminars for individual investors at the National Association of Investors, Investment Expo and the Money Show. She has also taught finance, economics and banking at the college level, and has been quoted extensively in The Wall Street Journal, Investor’s Business Daily, USA Today, and BusinessWeek. Now let her give you the tools and resources, including a monthly magazine, for gaining the peace-of-mind to live comfortably now and in retirement in her Cabot Money Club.Learn More >>