LEAPS Option

A LEAPS Option (an acronym for Long-Term Equity Anticipation Securities) is a special type of options contract with an expiration date that is much further into the future than a standard option. While typical options expire in a matter of weeks or months, LEAPS have a lifespan of more than one year, often extending up to three years from their issuance. This extended timeframe is their defining feature and is what makes them particularly interesting for a value investor. Because they don't expire quickly, LEAPS behave more like a long-term investment in the underlying stock. They allow an investor to control a large block of shares for a fraction of the cost of buying them outright. This provides a powerful way to gain exposure to a company's potential upside while risking a smaller, fixed amount of capital—the premium paid for the option. The long runway gives a well-researched investment thesis the ample time it needs to play out, perfectly aligning with a patient, value-oriented strategy.

At their core, LEAPS are just like any other option. They come in two main flavors:

• LEAPS Call Option: Gives the holder the right, but not the obligation, to buy 100 shares of a stock at a predetermined price (the strike price) on or before the expiration date. You would buy a LEAPS call if you are bullish and believe the stock's price will rise significantly over the long term.
• LEAPS Put Option: Gives the holder the right, but not the obligation, to sell 100 shares of a stock at the strike price on or before expiration. You might buy a LEAPS put to protect a long-term stock holding from a potential major downturn, acting as a form of insurance.

The key difference is time. The price of an option (the premium) is made up of intrinsic value and extrinsic value. Extrinsic value is essentially the “time value” of the option. Because LEAPS have so much time until they expire, their premiums are higher than those of short-term options on the same stock, but the rate of time decay (the erosion of this time value) is much, much slower.

For value investors, LEAPS aren't for wild speculation. Instead, they are a strategic tool for capital efficiency and risk management.

This is one of the most popular and practical uses for LEAPS. Imagine you've analyzed a company, “ValueCo,” currently trading at $50 per share. You believe it's undervalued and want to invest $5,000.

1. Option 1: Buy the Stock. You could buy 100 shares of ValueCo for $50 x 100 = $5,000.
2. Option 2: Use a LEAPS Call. Instead, you could buy a single LEAPS call option contract with a strike price of, say, $40, that expires in two years. This is known as a deep in-the-money call. Let's say the premium for this contract is $15 per share, or $1,500 total ($15 x 100 shares).

With the LEAPS call, you've spent only $1,500 to control the same 100 shares. You now have exposure to nearly all the upside of owning the stock, but your maximum loss is capped at the $1,500 premium you paid. The remaining $3,500 of your capital is now free to be invested elsewhere, perhaps in a low-risk asset like government bonds, or held in cash to seize another opportunity. This strategy works because a deep in-the-money call has a high Delta, meaning its price moves almost in lock-step with the underlying stock price. A Delta of 0.85, for example, means the option's price will increase by about $0.85 for every $1 the stock goes up.

Value investing is a marathon, not a sprint. It can take years for an undervalued company's true worth to be recognized by the market. Standard options, which expire in 30-90 days, are simply too short for this approach. They force you to be right about when the stock will move. LEAPS, with their 1-to-3-year lifespans, allow you to be right about what the stock will do, giving your investment thesis the necessary time to mature without the constant pressure of a ticking clock.

While powerful, LEAPS are not without their risks.

• Premium Risk: This is the big one. If your thesis is wrong and the stock price doesn't rise above your break-even point (strike price + premium paid) by expiration, your option can expire worthless. Unlike owning the stock, where you still own a piece of the business, with an option you can lose 100% of your initial investment.
• Slower Time Decay, But Still Decay: The “time decay” on a LEAPS option, known as its Theta, is very slow at first but accelerates dramatically in the last few months before expiration. A LEAPS option effectively turns into a short-term option as it nears its end date, and its value can evaporate quickly if the stock isn't moving in the right direction.
• Complexity: Options are derivative instruments and are inherently more complex than stocks. To use them effectively, an investor must understand concepts beyond just the stock price, including the Greeks (options) (Delta, Theta, Gamma, Vega) and implied volatility, all of which influence the option's price.