How to Buy LEAPS Options: A Step-by-Step Process

Long-term Equity Anticipation Securities, commonly known as LEAPS, are a type of options contract that offers investors a way to gain exposure to the potential price movements of an underlying asset over an extended period. Unlike standard options, LEAPS are designed with significantly longer expiration dates, typically spanning more than one year. This extended timeframe allows investors to potentially benefit from long-term trends in stocks or exchange-traded funds (ETFs) without the immediate pressures of shorter-term market fluctuations.

Defining LEAPS

LEAPS are options contracts characterized by their unusually long expiration periods, typically extending beyond one year, and sometimes up to three years from their issuance date. This distinguishes them from conventional options, which generally expire within a shorter timeframe, usually less than a year. Despite this difference in duration, LEAPS function similarly to other equity options, granting the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price.

Each LEAPS contract is tied to an underlying asset, such as a stock or an exchange-traded fund, and has a strike price and an expiration date. Like all options, LEAPS come in two forms: call options, which provide the right to buy, and put options, which provide the right to sell.

Essential Concepts for LEAPS Trading

Before considering LEAPS, understanding foundational options trading concepts is important.

• The underlying asset refers to the specific stock, ETF, or index upon which the LEAPS contract is based. The performance of this underlying asset directly influences the value of the LEAPS option.
• The strike price is the predetermined price at which the buyer of an option can purchase (for a call) or sell (for a put) the underlying asset. This price is fixed at the time the option contract is established.
• The expiration date is the final date on which the option contract can be exercised. After this date, the contract becomes void.
• Options are categorized by their relationship between the underlying asset’s current price and the option’s strike price. An option is in-the-money (ITM) if exercising it would result in a profit; for a call, this means the underlying price is above the strike, and for a put, the underlying price is below the strike. An option is at-the-money (ATM) when the underlying asset’s price is approximately equal to the strike price. An option is out-of-the-money (OTM) if exercising it would not be profitable; for a call, this means the underlying price is below the strike, and for a put, the underlying price is above the strike.
• The options premium is the price paid by the buyer to acquire the option contract. This premium is composed of two main parts: intrinsic value and extrinsic value. Intrinsic value is the immediate profit if the option were exercised, meaning it exists only for ITM options. Extrinsic value, also known as time value, accounts for factors like the remaining time until expiration and implied volatility.
• Implied volatility is a market’s forecast of how much the underlying asset’s price will fluctuate in the future. Higher implied volatility generally leads to a higher options premium, as there is a greater perceived chance of the underlying asset moving favorably.
• An options chain is a listing of all available options contracts for a given underlying asset, organized by expiration date and strike price. It displays key information such as bid and ask prices, trading volume, and open interest, allowing investors to identify specific LEAPS contracts.

Preparing to Place a LEAPS Order

Before placing a LEAPS order, investors must complete several preparatory steps.

A brokerage account capable of supporting options trading is required. Brokerage firms typically mandate specific options trading approval levels, which involve completing an application that assesses an investor’s financial situation, investment objectives, and understanding of options trading risks. This process often includes acknowledging risk disclosures and confirming financial information, which helps the brokerage determine the appropriate trading level.

Proper capital allocation is an important consideration. Investors should determine a specific amount of capital they are willing to dedicate to options trading, separate from their core investment portfolio. This ensures that potential losses, limited to the premium paid for the option, do not significantly impact their overall financial stability.

Thorough research of the underlying asset is also an important preliminary step. Since the value of a LEAPS contract is directly linked to the performance of the underlying stock or ETF, understanding the asset’s fundamentals, industry trends, and potential catalysts is important. This research informs the selection of an appropriate LEAPS contract and aligns the investment with the investor’s long-term outlook for the asset.

Placing a LEAPS Order

Executing a LEAPS trade involves navigating a brokerage platform’s options trading interface.

Selecting the LEAPS Contract

The first step is to locate the underlying asset and then access its options chain, which presents all available contracts. From this chain, the investor selects the desired LEAPS contract by identifying the specific expiration date, which will be more than a year out, and the chosen strike price.

Choosing an Order Type

Once the specific LEAPS contract is selected, the next step involves choosing an order type. A limit order is generally preferred for options trading because it allows the investor to specify the maximum price they are willing to pay per contract. This provides control over the execution price, which is important given that options premiums can fluctuate. While market orders offer immediate execution, they do not guarantee a specific price and can result in purchasing at a less favorable premium.

Entering Trade Details and Submitting

After selecting the order type, the investor must enter the specific details of the trade. This includes specifying the number of contracts to purchase, with each contract typically representing 100 shares of the underlying asset. The chosen order type and the desired price per contract are also entered at this stage.

Before submitting the order, a review screen will typically display all the order details, including the total estimated cost of the trade. It is important to carefully review these details to ensure accuracy, confirming the correct underlying asset, expiration date, strike price, and total premium. Upon confirmation, the order is submitted for execution, and the investor will receive a notification once the trade is completed.

Managing a LEAPS Position

After acquiring a LEAPS contract, ongoing monitoring of the position is important.

Monitoring Your Position

This involves regularly checking the performance of both the underlying asset and the LEAPS contract itself. Observing how the underlying asset’s price moves relative to the strike price, and how that impacts the option’s premium, provides insight into the position’s current value.

Exercising the Contract

One option is to exercise the LEAPS contract. For a call option, exercising means purchasing 100 shares of the underlying asset at the strike price, while for a put option, it means selling 100 shares at the strike price. This action typically requires sufficient capital in the account to fulfill the transaction.

Selling the Contract

Alternatively, an investor can choose to sell the LEAPS contract on the open market before its expiration date. This process is similar to the initial purchase, involving placing a sell order through the brokerage platform. Selling the option allows the investor to realize any gains or losses without needing to take possession of the underlying shares.

Expiration

If a LEAPS contract reaches its expiration date and is out-of-the-money, it will expire worthless, and the investor will lose the entire premium paid for the contract.