"LEAPS are Evil"

I wrote the title in parenthesis since I am not taking the credit for said statement. I am willing to look at both sides of this coin though. I will start with the strategy in general and then come back to this quote. Bear with me...

Does anyone out there trade LEAPS? If so...WHY? I will take the role of a critic now and criticize any LEAP option traders. I can see the reasons someone would use to explain why they trade them....

Leverage
"It's like owning the stock at a discount!"
Follows the stock closely (1:1 Delta)
More time until expiration...One day it will be profitable!!!

LEAPS are supposed to be long term options, right? This means we hold them over long periods of time in order to capitalize on longer term trends, etc. I would wager a bet that not one trader out there who trades LEAPS has held on to one longer than 2 months. Despite having anywhere from 7 months to 2 years I would be surprised to see that someone has help a LEAP longer than two months. If you have held one longer than two months, I will double down that you have not done it more than once.

Am I Right?

Why is this? Why would you trade LEAPS when you are not taking advantage of them? It is supposed to be the same approach as trading stock is. Intended for longer term holding through longer term trends, offers leverage, and offers you a discount to purchasing the stock. Have you looked at the price of the premiums? Let's use an example. Assume I love Apple Computers. Let's say I want to buy the first available LEAP. I would be looking at Jan 08's. To get 1:1 movement with the stock I would take the 50 strikes. They offer a delta of .888 which is close to .89, which gets rounded up to .90, and that puts us where we want to be. These options cost $29.40!

I can tell you that I know enough about my myself not to take a trade that doesn't offer me an advantage. I know that I could never hold a trade that long, so I don't trade LEAPS. Ask yourself, if you are not going to use the full amount of time until expiration, why would you pay for it?

Let me get back to the comment I heard the other day. I have been spending time learning the ways of the floor trader, and how they discount all analysis but price movement and probability. As I talk to this gentleman about his experience in the trading pit, we start to talk about LEAPS, and then this comment surfaces.

Like I said, floor traders discount all methods of technical analysis. This includes the three premises all technical analysts live and die for...

Market Action Discounts Everything
Prices Move in Trends
History Repeats Itself


As I started to dig deeper I could see that this comment was based solely on price structure. Which makes complete sense. Can you really put a price tag on that much time? A market maker can't...there is not enough liquidity or enough of a market to make an efficient price structure. Take a look at how they compensate...(Click to view larger image)



By increasing Implied Volatility for each extending month, this creates a larger premium for you to pay. The lack of activity creates huge spreads, and I was told that the maker knows that the order coming through is a retail order. Apparently institutional money doesn't trade LEAPS.

As I asked more questions, this gentleman claimed that one should never buy more than 150 days of time. This makes sense to me. This is what I teach. I have always suggested trying to gauge how much time you think you need, buying a little extra, and getting out after the stock has made your move. While I do not promote buying too much time, buy a little more than you were expecting to use. Just in case.

To tie this together, I don't have anything against LEAPS. But I do have something against the trader that buys them, and doesn't really use them. If I were you I would buy less time and get more contracts if you are the trader that doesn't take full advantage of them.

By the way, let's not go in the direction of "What if my strategy would be selling covered calls against my LEAPS" because those little premiums don't absorb the stock losing significant portions of it's value. When you start selling strikes lower than the strikes you purchased, you are in a bear spread.

I think I am done for the day, see you tomorrow.

GREAT ARTICLE AND SUBJECT MATTER
I PERSONALLY AGREE WITH YOU.
ROCK ON!!! STEVE L

Jeff,

I absolutely agree with you on analysis of LEAPS! I was thinking about this myself.

And yes you are right, I bought LEAPs on GG but only held onto to them for 2 months!

If I ever buy LEAPs again it would be to employ a calender spread strategy to pay for the trade over time. I am not sure I would have the patience to hold a trade for that long though.

Thanks for the elightenment

John

I will admit to holding a leap for 5 months. First leap purchased and the last. It would have been far better to have purchased the stock.

Jeff,
I am learning how the market makers (mms) trade. It is really interesting to see that it seems like the mms are ahead of the game versus the retail investors. For instance, I learned that around Friday noon mms quote the options with the weekend time decay already on them. So if you were only trading friday for the weekend time decay, you'd be out of look since it is already factor into the market.

So was the floor trader discounting technical analysis just for leaps (and you agreed with that), or does he discount technical analysis as a whole?

Jake H.

Hi Jeff, great blog. I need some clarification about selling calls against a LEAP. The little premiums should more than cover the value lost in the LEAP if the underlying stays about the same or goes up, right? Also, if you start selling strikes lower than your LEAP strike, you're in big trouble because your underlying has taken a dive! I guess I don't fully see your point.

Hal

Jeff,

I stumbled upon your blog by searching for CC on LEAPS. Now I know that at the end you made a disclaimer about writing CC on LEAPS, but I think this where you are losing the sight. The ones you are calling "little" premium can really payoff the time value and add some. Also, this will help you reduce your risk level from buying the straight stock.

You need to do things differently, instead of looking at the volatile stocks like Apple, look at the index options or ETFs, and see the Deep ITM calls are nearly zero time value. It will be easy to write calls against it without worrying to lose too much (if you were to buy a stock).

Second, you can make this a delta neutral position buy also buying deep ITM LEAP PUTs, and writing puts against it. Overall, it is a double diagonal with a winning edge.

Third, never underestimate the word "little" - as Einstein said, "there is no bigger force than compounding effect".

Fuck Off.

You Are WRONG WRONG WRONG!!! I am a former InvesTOOLS student to experienced/successful trader. I have been trading heavily with TOS with my dad and we made over 500 grand in the last 6 months with 1 security trading strictly LEAPS. I am actually launching a huge online trading website and LEAPS trading product in the next month. Would love to talk with you about a possible JV and trading ideas. Skype me at: TylerChianelli...would love to talk with you more..thanks & happy trading!

Also forgot to mention the initial investment was 200 contracts at $1.65 or about 35k in April. Now half of the position is ITM and trading over $40/contract. Where else can you get a 20+ bagger in less than 6 months!!?? LEAPS ALL THE WAY!!! If the OptionAddict can't teach them the Trading King will! :) Happy Trading

I can teach anything, fuckface.

Don't you think the market was the key to success behind this strategy? Don't give yourself too much credit.

OA

I really like when people are expressing their opinion and thought. So I like the way you are writing

Sorry for my bad english. Thank you so much for your good post. Your post helped me in my college assignment, If you can provide me more details please email me.

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I agree. The longer I held a leap was 3 months, and it was 3 months too much because the patience was more expensive than any benefit I had from options trading. I'm glad that someone else thinks like me.

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About me

  • I'm Option Addict
  • From Saratoga Springs, Utah, United States
  • I am a professional trader and an instructor for Investools. I've had relations with the markets for 9 years. Born in Concord, CA, but reside in Saratoga Springs, Utah. Father of THREE, Husband of one.
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