Stock LEAPS

Stock LEAPS are long-term stock options. The term is an acronym for Long-term Equity AnticiPation Securities. They can be either a put or a call. Stock LEAPS typically become available for trading in July, and at first, they have a 2½-year lifespan.

As time passes by, and there are only six months or so remaining on the LEAP term, the option is no longer called a LEAP, but merely an option. To make the distinction clear, the symbol of the LEAP is changed so that the first three letters are the same as the company's other short-term options.

Stock LEAPS are Tax Friendly

All LEAPS expire on the third Friday of January. This is a neat feature because if you sell a LEAP when it expires, and you have a profit, your tax is not due for another 15 months. You can avoid the tax altogether by exercising your option. For example, for a call option, you purchase the stock at the strike price of the option you own.

All Options Decay, But All Decay is Not Equal

All LEAPS, like any option, go down in value over time (assuming the stock price remains unchanged). Since there are fewer months remaining until the expiration date, the option is worth less. The amount that it declines each month is called the decay.

An interesting feature of the monthly decay is that it is much smaller for a LEAP than it is for a short-term option. In fact, in the last month of an option's existence, the decay is usually three times (or more) the monthly decay of a LEAP (at the same strike price). An at-the-money or out-of-the-money option will plunge to zero value in the expiration month, while the LEAP will hardly budge.

Buy LEAPS To Hold, Not To Trade

One unfortunate aspect of LEAPS is due to the fact that not many people know about them, or trade them. Consequently, trading volume is much lower than for short-term options. This means that most of the time, there is a big gap between the bid and asked price.

The person on the other end of your trade is usually a professional market maker rather than an ordinary investor buying or selling the LEAP. These professionals are entitled to make a profit for their service of providing a liquid market for inactively traded financial instruments such as LEAPS. And they do. They manage to sell at the asked price most of the time, and to buy at the bid price. Of course, you are not getting the great prices the market maker enjoys.

So when you buy a LEAP, plan on holding it for a long while, probably until expiration. While you can always sell your LEAP at any time, it is expensive because of the big gap between the bid and asked price.