LEAPS
LEAPS (Long-Term Equity AnticiPation Securities) are options contracts with expiration dates more than one year away — typically one to three years — available on many large-cap U.S. stocks and major indexes.
LEAPS were introduced by the CBOE in 1990 to give investors access to long-term options contracts that more closely resemble the time horizons used in fundamental stock analysis. A standard monthly option expires in a matter of weeks or at most months; a LEAPS contract can extend 24 to 36 months into the future, fundamentally changing the risk/reward dynamics of options investing.
The extended time horizon of LEAPS dramatically increases their premium relative to short-term options — and for good reason. A LEAPS call with two years to expiration has extensive time value reflecting the long window for the stock to rise above the strike. However, because vega and time value are large, LEAPS are also highly sensitive to implied volatility changes. A volatility compression of 10 percentage points could reduce a LEAPS premium by a significant amount even if the stock moves favorably.
The most popular use of LEAPS is as a stock substitute. An investor who wants exposure to 100 shares of a high-priced stock without committing the full capital can purchase a deep in-the-money LEAPS call with a delta near 0.80 or higher. The LEAPS moves in near-lockstep with the stock while costing a fraction of the share price, providing leverage. This strategy — sometimes called a 'LEAPS replacement strategy' — is used by value investors who want long-term upside with defined downside risk.
LEAPS also serve as a hedging tool. Buying a long-dated put LEAPS on an equity portfolio provides insurance against a multi-year bear market without the need to roll short-term puts every month. The lower transaction frequency reduces costs and slippage compared to rolling monthly puts.
From a tax perspective, LEAPS held as long options for more than one year and then sold or exercised may qualify for long-term capital gains treatment in the U.S., though tax rules are complex and investors should consult a tax advisor. LEAPS that are exercised do not automatically receive long-term treatment — the holding period of the acquired shares begins at exercise, not at LEAPS purchase.