If you want to speculate on the decline of a stock's price, but want to make only a small investment over a limited time, you might consider buying a put option. These contracts give you the right, but not the obligation, to sell a stock at a certain price. If the stock falls, the option's value increases. Although the most common options expire in a range of just a few months, long-term options are also available.
Long-Term Equity AnticiPation Securities, or LEAPS, allow you to keep an option position open for a long period of time. Investors may buy and sell these securities in the open market, much like ordinary stock options or stock shares. LEAPS can be used to speculate on a future move in the underlying stock, or to hedge against a strong move against you if you hold shares of the stock in your account.
Volatility and Risk
You can trade LEAPS on more than 300 underlying stocks and 11 stock indexes. LEAPS limit your downside risk to the full price of the option, as long as you are “going long” or buying the option, and not selling it. Options, however, are more volatile than shares of stock, as the option price moves through a much greater range, as a percentage of your investment, than does the price of the underlying stock. You also risk a loss of your entire initial investment if the option expires worthless.
While ordinary options expire throughout the year, LEAPS expire only in the month of January. There can be a series of several LEAPS offered on a single stock, each with an expiration date in a different year. The expiration date is the Saturday following the third Friday of the month, but trading in the option technically stops on the Friday. The Chicago Board Options Exchange, which sets the rules for LEAPS, allows these options to expire up to 39 months after they begin trading.
Closing the Position
The exchange adds new LEAPS options once a year, or after substantial moves in a stock or in the market. You may sell a LEAPS option any time you wish. If you reach the expiration date and the underlying stock price is above the option’s strike price, then the option expires worthless. If the stock price is below the strike price, then the option is automatically exercised and your broker credits your account with the cash proceeds. The amount credited may be more or less than the amount you initially invested in the option.