This article explains how to trade LEAPS (Long-Term Equity Anticipation Securities) call options for profit, even potentially retiring with $100,000 using this strategy. It's designed for both beginners and those who have traded LEAPS options without consistent success. This information is for educational purposes only and should not be considered financial advice.
What are LEAPS?
LEAPS are options contracts, either call or put, that expire in 365 days or more. This article will focus specifically on LEAPS call options, particularly relevant in a bull market. The key advantage of LEAPS is their lower Theta Decay (time decay) compared to shorter-term options.
Understanding Theta Decay
Regular call options lose value daily due to theta decay. This necessitates being correct about the direction of the stock and the timing of the move. LEAPS offer a longer timeframe, reducing the pressure of immediate price movement.
Benefits of LEAPS Call Options
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Extended Time Horizon: 365 days or more to be right.
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Reduced Theta Decay: Slower value erosion compared to shorter-term options.
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Unlimited Upside Potential: No limit to potential profits if the stock rises significantly.
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Leverage: Control 100 shares of stock for a fraction of the cost (typically around 3:1 leverage).
Break-Even Point
The break-even point for a LEAPS call option is the strike price plus the premium paid. For example, if you buy a call option on Nvidia with a $100 strike price and pay $2,000, your break-even point is $120. The stock must be at or above $120 at expiration to make a profit.
Backtesting the Strategy
A backtesting tool was used on the QQQ (NASDAQ 100 index) over the past two years. Buying a 70-Delta LEAPS call option expiring in 365 days showed a 151% return on capital, compared to a 57% return from simply buying and holding QQQ. This illustrates the potential leverage offered by LEAPS options. This strategy typically works well in a bull market.
Key Factors for Profitable LEAPS Trading
Selecting the Right Stocks
- Good Chart: The stock should have an upward-trending chart, indicating positive investor sentiment.
- Good P/E Ratio: A lower P/E ratio compared to the S&P 500 average (currently around 20-28) is generally favorable from a valuation perspective.
Example: Robinhood vs. Charles Schwab
Comparing Robinhood (HOOD) and Charles Schwab (SCHW), both in the financial brokerage sector, highlights the importance of chart analysis. While Charles Schwab may have a better P/E ratio, its stock price has remained stagnant over the past year. Robinhood, on the other hand, has nearly tripled in value, suggesting greater growth potential.
Options Chain and Delta
When selecting a LEAPS option, choose an expiration date 365 days or more out. Aim for a Delta of around 70. Delta indicates how much the option price will change for every $1 move in the underlying stock. A 69 Delta means that, for every dollar the stock goes up, the option will make .69 cents.
Example: Robinhood LEAPS Option
For Robinhood, considering the 361-day LEAPS option with a 69 Delta at the 45 strike price, the cost would be approximately $1,485 to control 100 shares. The theta decay is also lower than shorter dated options.
Timing Your Entry
- VIX (Volatility Index): Monitor the VIX, which measures fear in the S&P 500 options market. Look to enter LEAPS positions when the VIX is above 15, indicating higher fear levels and potentially better entry prices. A high vix indicates a good time to buy.
- Lower Bollinger Band: Aim to buy stocks near their lower Bollinger Band. Bollinger Bands indicate the stock's price range, and entering near the lower band suggests the stock may be undervalued.
Bollinger Bands Explained
Bollinger Bands consist of an upper and lower band, two standard deviations away from the average stock price. The price stays within the range of the bands 95% of the time.
Example: Amazon
Amazon is used as an example of a decent entry point as it's neither near the upper or lower Bollinger Band. The VIX is high and the price is a long way off from all-time highs so this could be a good entry.
Exit Strategies
- 20-50% Profit in 14 Days or Less: Take quick profits when available.
- Price Targets: Set predetermined price targets based on support and resistance levels.
- Long-Term Position Building: Add to the position on dips and maintain it for an extended period.
Generating Income with Covered Calls
This advanced strategy involves selling covered calls against existing LEAPS options. This can generate income, but carries the risk of having the LEAPS options called away if the short call goes in the money. This is a more advanced strategy and more research is needed before attempting this.
Covered Call Example
If you own a LEAPS option at $100, selling a $105 call option against it generates income if the stock stays below $105. However, if the stock rises above $105, the LEAPS option could be called away.
Three Stocks to Consider for LEAPS
- Robinhood (HOOD): Although approaching the upper Bollinger Band, it is still significantly down from all-time highs.
- SoFi (SOFI): Good for smaller accounts, with a lower share price and potential for growth.
- Palantir (PLTR): Highest risk, but also high upside potential, though currently at the upper Bollinger Band.