LEAPS stands for Long-term Equity AnticiPation Securities. In a nutshell, they are long term options that have anywhere from 9 months to almost three years of life. As with any trading vehicle, there are risks and benefits associated with LEAPS options.

Benefits:

LEAPS traders benefit from options that have at least nine months until expiration. If you are a long term trader, this may be a strategy you could incorporate into your trading portfolio.

By virtue of having such a long time before option expiration, these options trade at relatively high premiums. While this may not be a good thing for the option buyer, this is a good thing for the option seller (writer). Therefore, traders who are looking to trade covered calls while collecting a substantial premium may gravitate toward LEAPS options.

Due to the way time decay works in longer term options, a trader may find it preferable to trade LEAPS options. Due to their nature, the daily time decay amount (theta) is very small. This allows traders to concentrate on other ways of profiting such as market direction and changes in implied volatility levels without much concern for time decay eroding a position.

Depending on how one structures one’s trading account, LEAPS options may offer certain tax benefits. For more information, contact a qualified tax authority.

Risks:

LEAPS do not expire for at least nine months and may exist for almost three years. Therefore, a covered call trader who initiates a position by selling (writing) a LEAPS option against his long stock position may have to wait years in order to realize the premium collected on a trade. For many traders, this may not be a preferred way to trade as it may tie up capital (stock) for an unnecessarily long time.

For traders who purchase options for use as stock substitutes, they may find that the premiums associated with long term options are higher than what is preferred by their personal risk levels. All else equal, the longer the time to expiration, the higher the premiums associated with an option.

While LEAPS may be an attractive investment for those looking to minimize the effects of time decay on their option positions, these options have a much higher sensitivity to changes in implied volatility levels (vega). Therefore, a trader may opt to become well versed in the intricacies of option volatility prior to engaging in the trading of LEAPS.

LEAPS offer minimal gamma. While this may not be a concern for call and put buyers, it merits consideration for more advanced traders looking to use spreads and other strategies that negate or minimize the effects of volatility in a position. If placed incorrectly, spreads using LEAPS may lead to positions that fail to generate the expected income even with a substantial move in the underlying in the preferred direction.