Options are usually seen as tools for the "fast money" crowd. If an option trader can correctly forecast a stock's price within a specific time frame and buy the appropriate option, huge profits can be made in a few months. However, if the prediction is wrong, then the same option could easily expire worthless, wiping out the original investment. However, options can also be useful for buy-and-hold investors. Sinceinvestors have been able to buy options with expiration dates ranging from nine months to three years into the future.

These options are known as LEAP Long-Term Equity Anticipation Securities options. Buying LEAPs Investors can purchase a LEAP call option contracts instead of shares of stock in order to get similar long-term investment benefits with less capital outlay. Substituting a financial derivative for a stock is known as a Stock Replacement strategyand is used to improve overall capital efficiency.

Rolled LEAPs The biggest problem with options for the buy and hold investor is the short-term nature of the security. And even LEAP options, with expirations over a year, may be too short for the most ardent buy and hold investor.

However, a LEAP option can be replaced by another LEAP with a later expiry. For example, a two-year LEAP call could be held for a single year and then sold and replaced by another two-year option. This could be done for many years, regardless of whether the price of the underlying security goes up or down.

Making options a viable choice for buy and hold investors. Selling older LEAP calls and purchasing new ones in this manner is called the Option Roll Forwardor sometimes just the Roll. An investor makes regular small cash outlays in order to maintain a large leveraged investment position for long periods. Rolling an option forward is inexpensive, because the investor is selling a similar option with similar characteristics at the same time.

However, predicting the exact cost is impossible because option pricing depends upon factors such as volatilityinterest rates and dividend yield that can never be precisely forecasted.

Using the spread between a two-year and one-year option of the underlying security at the same strike priceis a reasonable proxy. The Four Advantages Of OptionsAlternatives To Closing Below Intrinsic Value and Reducing Risk With Options.

Using LEAP calls, like any stock-replacement strategy, is most cost-effective for securities with low volatility, such as index or sector ETFs or large-cap financials, and there's always a tradeoff between how much cash is initially put down and the cost of capital for the option.

An at-the-money option on a low volatility stock or ETF is generally very inexpensive, while an at-the-money option on a high volatility stock will be significantly more expensive.

Leverage Ratio and Volatility At the money LEAP call options initially have higher leverage and volatility. The bull phase in the stock market should be prepared for this volatility. Over periods of years, as the underlying security appreciates and the call option builds equity, the option loses most of its leverage and becomes leap call options definition less volatile.

Given multi-year holding periods, the results of the investment are relatively predictable using statistics and averages. Because options have deltathey receive some appreciation immediately, and then accumulate leap call options definition remainder as they get closer to expiry.

This also makes them more suited for investors with longer holding periods. Discounted cash flow calculations can be used to determine both the cost of capital and the expected appreciation.

The annual roll-forward cost is unknown, but we'll use, as a proxy, the cost difference between a December option and a December option at the same strike price.

It could go up or down next year, but over time, it's expected to decline. The investor will pay the roll-forward cost three times in order to extend the two-year option taxability of nonstatutory stock options a five-year holding period.

Note that in the above example, we excluded dividends. Option holders don't receive dividends, but they do benefit from lower option prices in order to account for the expected future dividend payments. When calculating expected returns for any LEAP, be consistent and either include or exclude dividends from both the cost of capital and the expected appreciation. The Bottom Line Most buy-and-hold investors and index investors are not aware that LEAP calls can be used as a source of investment debt.

Using LEAP call options is more complex than purchasing stock on marginbut the rewards can be a lower cost of capital, higher leverage and no risk of margin calls. LEAP call options may be purchased and then rolled over for many years, which allows the underlying security to continue to compound as the investor pays the roll forward costs.

If the option is deep-in-the-money and the underlying security has low volatility, then the cost of capital will be low. LEAP calls can give investors the ability to construct long-term portfolios of stocks or index ETFs and thereby control larger investments with less capital.

Of course, it's always important to plan purchases, sales and future roll-forward costs carefully, as exiting a large leveraged investment during a downturn will most likely lead to significant losses. Despite the fact that many option buyers are short-term hedgers or speculatorsan argument could be made that leveraged investments are only appropriate for investors with very long horizons.

Using LEAPS In A Covered Call Write and Trading A Stock Versus Stock Options - Part 1. Dictionary Term Of The Day.

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Rolling LEAP Options By Tristan Yates Share. The Four Advantages Of OptionsAlternatives To Closing Below Intrinsic Value and Reducing Risk With Options Using LEAP calls, like any stock-replacement strategy, is most cost-effective for securities with low volatility, such as index or sector ETFs or large-cap financials, and there's always a tradeoff between how much cash is initially put down and the cost of capital for the option.

Stock Ticker SPY Price Learn how to multiply returns and diversify risk by buying options instead of stock. Investing in long-term call options can lead to a huge payoff if they are used right. Index options are less volatile and more liquid than regular options. Understand how to trade index options with this simple introduction.

LEAP Options - LEAP Option Definition, Trading Examples

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