LEAPS (finance)
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In finance, LEAPS (an acronym for Long Term Equity Anticipation Security) are options of longer terms than other more common options. LEAPS are available on approximately 2500 equities and 20 indexes. As with traditional short term options, LEAPS are available in two forms, calls and puts.
Options were originally created with expiry cycles of 3, 6, and 9 months, with no option term lasting more than a year. Options of this form, for such terms, still constitute the vast majority of options activity. LEAPS were created relatively recently and typically extend for terms of 2 years out. Equity LEAPS always expire in January. For example, if today were November 2014, one could buy a Microsoft January call option that would expire in 2015, 2016, or 2017. The latter two are LEAPS.
When LEAPS were first introduced in 1990, they were derivative instruments solely for stocks; however, more recently, equivalent instruments for indices have become available. These are also referred to as LEAPS.
Applications
LEAPS are often used as a risk reduction tool by investors. For example, in an article in Stocks, Futures and Options (SFO) magazine, Dan Haugh of PTI Securities & Futures suggests that stock investors can manage risk and price protection by considering purchase of an exchange-traded fund and “..buying put protection on that ETF with LEAPS." [1] In the case of stocks, the risk reduction application is when the owner of the stock writes LEAPs on his holding. The owner of the stock essentially creates the LEAP. The result at the expiry of the LEAP can be determined from its exercise price. (LEAPs are written for a wide variety of exercise prices.) If the stock closes below the exercise price, the buyer of the LEAP has lost what he spent to buy the LEAP. If the close is higher than the exercise price, the LEAP typically will automatically be exercised by the broker. The buyer can then sell the stock. His cost of the stock to the LEAP buyer will be the cost of the LEAP plus the exercise price (and any commissions). Most often the buyer of the LEAP is a speculator who hopes that the stock will rise enough in market price for him to make a profit when the LEAP expires.
See also
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