What are Long-Term Equity Anticipation Securities (LEAPS)?

//What are Long-Term Equity Anticipation Securities (LEAPS)?
What are Long-Term Equity Anticipation Securities (LEAPS)? 2017-11-09T03:35:34+00:00

Definition: A Long-Term Equity Anticipation Security (LEAPS) is an option’s contract that is set to mature in a period longer than one year. These contracts are an alternative for long-term investors looking for a way to get a wider time frame for their option’s investments.

What Does Long-Term Equity Anticipation Securities Mean?

Also known as LEAPS, these securities can be based on either individual instruments or indexes, such as the Dow Jones Industrial Average. Their purposes can vary widely depending on each investor. Some may use them as a hedge alternative to protect themselves from adverse long-term movements and others might use them as a way to get exposure to long-term investments without committing themselves fully to a stock or index.

The price of LEAPS varies depending on the market’s attitude towards the future price of the underlying asset. They work exactly the same as short-term options, the only difference being their expiration date.

For example, LEAPS call gives the investor the right but not the obligation to exercise the option at the strike price at any given point of its lifetime, which is the same as a regular call option. On the other hand, premiums charged for issuing a LEAPS are usually higher than those of regular option contracts, as its expiration period is longer than usual.

Let’s look at an example.

Example

Mario is looking to buy a couple different shares from companies he knows will perform well over the long term. He doesn’t have enough capital to purchase that many shares, so he decided to buy a bunch of LEAPS options to build a long-term portfolio with these stocks.

The LEAPS calls he bought are set to mature in 2 years, meaning that Mario can exercise them at any given point if the price of the underlying asset is higher than the strike price. This would be a profitable scenario for him. Mario also has to estimate the cost of the premiums paid for the LEAPS as part of his return on investment, as the premiums are high for such contracts.

Thus, his profit for the transaction would be the difference between the fair market value of the stock and the strike price less the premiums paid on the options.