What is a LEAP option?

on Sep 27, 2012 in Derivative, Home | 1,824 comments

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Long-Term Equity Anticipation Securities or LEAPs are very similar to standard options except for the fact that expiration occurs 36 months after purchase. They can be safer than traditional options because it is somewhat easier to predict share movements over longer periods. Therefore, they can be effective for both leverage and hedging purposes.

Investors can purchase a LEAP call option contracts instead of shares of a company in order to get similar long-term investment benefits with less capital outlay. Substituting a financial derivative for a share is known as a share replacement strategy, and is used to improve overall capital efficiency.
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 simply pays the roll forward costs.

Investors could purchase LEAPS put options as long term insurance against a catastrophic fall. In terms of price, LEAPS put options cost much lesser than all the short term monthly put options added together. This is why investors seeking to hedge for the long term should not hedge using short term put options. Hedging using short term options also result in more trades as short term options expire, resulting in higher commissions cost.