So you want to buy an expensive stock like AAPL, AMZN or GOOG but don't want to tie up the capital in your IRA or other accounts? Maybe it's time to consider LEAPS.
So you want to buy an expensive stock like AAPL, AMZN or GOOG but don’t want to tie up the capital in your IRA or other accounts? Maybe it’s time to consider LEAPS.
LEAPS Options were started in 1990 for the sake of long-term leveraged speculation. Instead of committing a significant amount of capital to a stock position, investors speculating on the long-term growth of a stock up to 3 years out could choose to buy the stock's LEAPS call options instead. LEAPS call options cost only a fraction of the price of the underlying stock and can allow you to capture as much profit as the delta value of those options allows you to. In fact, even if you choose to buy deep in the money LEAPS call options with delta value close to 1, it will still be much cheaper than buying the stock itself.
Let’s take a look at an illustrative trading example using a hypothetical stock. It is important to know that an in-the-money LEAPS call can be expected to move closely with the underlying stock as it advances. The cost of the LEAPS call is significantly less than the cost of stock ownership. This means that a reduced-risk position can be purchased for a meaningful length of time, 19 months in this example.
Although both a LEAPS call and a long stock position face the risk of a declining stock price, the cash at risk with the LEAPS call is considerably lower. Remember, the owner of a LEAPS call does not have the right to receive dividends or to vote in corporate affairs. Note also that the position in LEAPS calls in this example represents only the amount of stock that one might want to purchase, i.e., one LEAPS call represents 100 shares of the underlying stock.
Position 1—Long stock: Buy 100 XYZ at $50 ($5,000 capital investment)
Position 2—Long in-the-money LEAPS call: Buy one 19-month LEAPS 45-strike call at $9 ($900 capital investment)
Target for XYZ: In 19 months to be $90 per share
It is obvious that the LEAPS call costs less than the long stock position, but let’s compare the results. Assume that shares of XYZ advance 40 points at expiration in 19 months. XYZ stock increases to $90 for a paper profit of $4,000, not including commissions. This is a little more than a 50% annualized return on the $5,000 investment in the stock.
The LEAPS call, however, increases in value by $45 (the stock price of $90 minus the strike price of $45) for a profit of $3600 ($36x100), not including commissions. This is more than a 250-percent return on the $900 cost of the LEAPS call. The appreciation of the LEAPS call is $4 per share less in absolute dollar terms, but the initial investment and risk was $4,100 less.
Outright buying expensive stocks can be successful if the bull market continues, but to grow your IRA and to build wealth, it’s important to effectively allocate your capital.
Julie Saltzman has been involved in the trading industry for over 25 year as a writer, a floor trader and an educator. Saltzman began her career as a trader for Banque National de Paris in the currency option pits of the Chicago Mercantile Exchange and has spent the past five years exclusively in the trading education space. She is passionate about helping to level the playing field for all investors and is currently the Senior Project Manager for TraderPlanet PRIME, an online portal that provides exclusive interactive education and actionable trade strategies for your IRA.