What Are LEAPS in Options Trading? (How to Magnify Stock Returns)

options traders typically put on positions with 30 to 60 days to expiration meaning that their stock price outlook or prediction is usually falling within a one to two month time frame but in this video we're going to talk about leaps which are longer-term options and more specifically we're going to talk about the differences between trading short-term options and longer-term options or leaps and some of the things that you need to be aware of when trading leaps I'm also going to show you how leaps can magnify your stock price returns by comparing a leap option or long term options percentage gain relative to the same movement in the stock price really quickly I want to mention that I just launched a new youtube channel that we'll be focusing primarily on more broad investing and Finance topics so if you enjoy my work on this channel I would really love to have you as a subscriber on my other channel so if you're interested in more general finance and investing topics and you would like to follow me on my other channel I will leave a link to my other channel in the description and as I said I would love to have you as a subscriber so first and foremost what are leaps leaps are long-term equity anticipation securities or leaps for short to me leaps are options with more than a year to expiration meaning they have 365 days or longer until they expire but if you look around on the internet you might find some different time frame definitions but at the end of the day a leap option is an option with a lot of time until expiration if we take a quick look at the available expiration cycles for s P Y which is the sp500 ETF you'll notice that there are a ton of different expiration cycles that we can choose from ranging from 0 days to expiration meaning these options are expiring today all the way out to December 2022 which is about 960 days out or 2 and a half years until these options expire so these longer-term options specifically with a year or more until expiration are called leaps or long-term equity anticipation securities they're called leaps because as the name suggests if a trader puts on a position in an expiration cycle with two years to go they are putting on a trade with a 2-year time frame for whatever stock price prediction they may have let's hop over to the tasty works trading platform so we can discuss leaps in real time and look at some real options that are currently trading and so I can show you the differences between short-term options and long term or leap options and then we can look at an example of how these options perform relative to changes in the stock price all right let's go ahead and take a look at some leap options on SPI which is the S&P 500 ETF so as I mentioned earlier Leap options are typically defined as options with more than a year to expiration at least that's how I think of them but honestly you could think of these longer-term expirations such as November in December 2020 you could consider these leaps too since they are six to seven months out but typically if I'm gonna make a leap option trade I'm gonna be at least a year out and in most cases two years out or sometimes I'll just trade in the most long term expiration cycle that I can such as the December 2020 to expiration here which has 953 days to go which is about two and a half years out so these are super long term trades and the reason you would want to trade leap options as we'll discuss shortly is that you can amplify your gains relative to the movement in the stock price so by purchasing a leap call option for example if SP Y goes up 10% the leap call option that I buy is going to experience a far greater return than 10% and we'll look at some examples of that in just a moment and I'll show you how you can actually put the option price on the chart so that you can see the price changes of the leaps but let's go ahead and compare a few things here the first thing I want to compare is liquidity so if we go to the May 20 2010 cycle with 8 days to go this is considered the front month expiration cycle meaning it's the standard monthly expiration cycle and it's the most near-term standard monthly expiration cycle so since we're in May that's going to be May but once these expire the front month will be June and so on so the first thing I want to want to point out is that the open interest is in the tens of thousands for basically all of these Streng prices so that means there's tens of thousands of open option contracts between two parties and all these different strike prices and that means that there is a ton of trading activity in this particular expiration cycle we can also see that the bid-ask spreads are very very wide or very narrow and that is a result of all the trading activity that's taking place so if I look at the 290 call the bid is 352 the ask is 355 so 2 to 3 cents wide there so if we go out to January 2022 the first thing you'll notice is that the open interest and a lot of these strike prices is somewhat thin so we have some strikes with hundreds of open interest some in the thousands and this is still decent in my opinion for a two-year call option or two-year option so to speak these options have so much time to expiration that people are not actively trading these people are mostly entering these for long term holds since they do have 600 days to expiration so because of the decreased trading activity and these options we can see that the bid-ask spreads are wider so for example if we look at the 300 call option the bid is 2743 the ask is 27 84 so we're seeing a bit ask spread that's over 40 cents here and when we looked at the call option in the may 20 20 X / Asian cycle we saw that the bid-ask spread was 3 cents so the first big difference when you're trading leaps is that you will have less liquidity meaning there will be less open interest meaning that there are fewer open contracts between two parties and the volume will also be lower so if I go to volume you can see that the volume is really low and that's because people are not actively trading these people are just entering these positions and holding it for the long term as they do have over 600 days to expiration so if I quickly go to May 2020 is in the thousands so no surprise there so going back to January 2022 what I want to compare now is the prices so if we look at the 300 call option we can see that this price is 27 50 or so and if I click on the ask price which basically sets up in order to buy this option we can see that this option is actually worth about $2,800 that's because we have to take the quoted price of about 20 750 multiplied by 100 which is the option contract multiplier and we get the option value of 2800 if we look at the 300 call in the May cycle the 300 call is worth 40 cents so that's $40 so obviously there's a huge price difference here and that's because with 600 days to go there is a much larger expected range for the SP 500 over a two-year period and that's why these options are significantly more expensive but this brings me to my next point even though they're more expensive it doesn't necessarily mean it's a bad thing because the longer term options are actually going to have less decay so if I click again on the 300 call option more specifically clicking on the ask to set up a buy order we can see that the theta is negative 2.6 so this means with each passing day assuming no change in implied volatility and no change in the stock price I would lose about 2 dollars and 60 cents per day if I bought this call option so losing 2 dollars a day on a $2,800 option is not a big deal at all and as we can see the Delta is 50 and that means if the stock price or SP Y goes up one dollar this is expected to gain $50 in value so basically if SP Y went up one dollar in a day the cost of time decay would be negative two point six dollars but I would effectively make $50 from the directional change and therefore I would still come out ahead so the big difference here is the decay if I go back to May and I look at the at the money option which is the 290 it's trading for 350 but the theta is negative 23 so this option is far less expensive but it has way more decay and that's because it expires in 8 days now the reason I wanted to make this video is because I think leap call options particularly on stocks or products that you are bullish in is a phenomenal long-term strategy particularly if you are bullish on a stock the next year you can use leap calls to gain immense upside exposure so I'm gonna right click on this if you right click on either of the prices on tasty works it'll save view option and chart so I'm gonna do that on the 300 call and we're gonna view the option price in the chart so as we can see here this basically looks like a chart of s P Y and that's because this is a call option which is a positive Delta position and this is going to track the changes in s py very closely so as we can see we had the big rally up up until February 2020 then we had a massive collapse and now we're rallying back up so if we look at the actual change in the option price and remember this is the 300 call option in January 2022 which is about two years out we can see that at the bottom of this market move this call option was worth four dollars and 20 cents if we can look on the right-hand side of the chart so the bottom was four dollars and 27 cents and currently with a market rally this option is back up to 28 dollars so if we do that math really quickly for 32 to about 28 I'll just do the current option price is $28 at the bottom it was $4 if I do minus one that's a 600 percent gain so from the button from the market bottom in March to the current market level this 300 call option with two years to go experienced a 600 percent price increase let's compare that with the actual price increase in spy so if I just go to s py the bottom was 218 and currently it is at 287 so if I do 287 divided by 2 18 minus 1 we get a 32% increase so the 300 call option expiring in two years increased 600 percent from the market bottom to the current level but SP Y itself increased 32 percent the 300 call option expiring in two years experienced 20 times the pricing Cree's compared to s py s py went up 32 percent so basically if you were lucky and you bought shares of s py at the bottom and you held until now you are up 32 percent on your investment but if you had bought the leap call option particularly the 300 strike expiring in two years and you bought that at the market bottom and held it until now you are up six hundred percent on your investment so I'm not necessarily saying that you would have bought right at the bottom and held until now I am merely comparing the two price movements so that we can understand how a leap call option will change relative to the change in the stock price itself so as I said before by purchasing a leap call option you can get immensely leveraged upside potential compared to changes in the stock price and that's because as we saw here s py went up 32 percent but the leap call option expiring in two years with the strike price of 300 went up 600 percent in terms of trade management I would not recommend actually holding until expiration because as we saw here if you bought those calls with the three hundred strike and you wrote them up until now I would actually probably take a portion of those positions off to lock in a bunch of gains but then you could hold a portion of those and let them ride out for another year or so I hope that discussion was helpful for you and now you have a better understanding of what leaps are as we discussed in the video it's important to keep an eye on the liquidity or the open interest and volume of the leaps but more importantly the open interest is what you're gonna want to look out for not all stocks are going to have good leap markets or long term options because in a lot of stocks you're going to find that if you look at a two-year call option for example the open interest is going to be close to zero and there will be no volume in there and as a result I wouldn't recommend trading long term options in stocks such as those but in something that is incredibly active and popular such as the S&P 500 ETF or popular stocks such as Apple or Google I think you can safely trade leaps as long as you pay attention to your fill prices and try to get filled at the mid or lower as I mentioned when we were on tasty works I am not recommending that buying leap call options or long term call options is an easy trade by any means there's still a lot of risk but the benefit of buying long-term call options is that if you are right and the stock price does increase you are going to have a significant percentage return on the money that you've allocated to that call option position compared to the same movement in the stock price you might be wondering why I didn't really talk about implied volatility when talking about purchasing long term call options and the reason for that is that typically long term expiration cycles that have two years out until expiration those implied volatilities are going to be very stable and typically those are going to trade with higher levels of implied volatility than the near-term cycle and that's typically when we're talking about a lower volatility environment so if we had a 15 VIX the near-term spwhy option cycles would be trading with implied volatility is around 15% and it would be typical to see the longer-term expiration cycles trading with implied volatility over 20% in that scenario but at the end of the day it is still a risk you do have volatility risk meaning that if you bought options in a super far out expiration cycle and implied volatility comes down a few percentage points you are going to experience some losses on those options assuming that there's no change in the stock price but typically if we saw a few percentage points decrease in the implied volatility then that means that the stock price is typically rising and the volatility in the market is coming down as a whole so in theory you should probably still see some profits if you saw the stock price go up 10 or 20 percent and implied volatility came down a few percentage points but the most important thing is that in those long term expiration cycles the implied volatilities will be very stable and you should not expect them to fluctuate around a lot if you do decide to go out and invest in some long term call options with two years to expiration just keep in mind that you are still buying options and if the stock price stays below that called strike price over time you are going to lose money on that investment so only invest an amount that you would be comfortable losing 50% of or a hundred percent of but since you have two years to go and especially if you are investing in SP why call options which is a very safe product to be bullish on long term and I think you'll be fine as always thank you so much for watching my name is Chris from Project option and I hope you learned something from this video I'll see you next time

Channel: projectfinance

Views: 129,412

Rating: 4.9492388 out of 5

Keywords: leaps options strategy, leaps options trading, leaps stock options, what are leaps options, long term equity anticipation securities, long term options trading, buying LEAPs calls, buying calls, how to 10x stock returns, what are leaps in options trading, what are leaps

Id: _72NBuq6TOg

Length: 16min 14sec (974 seconds)

Published: Thu May 07 2020