The suitability of a LEAPS option depends heavily on the outlook of the investor/trader, his/her specific trading approach, and his/her risk profile.
Listed below are some of the considerations investors and traders can use when considering LEAPS options positions.
Pros of LEAPS Options
Extended Timeframe: With expiration dates up to two or three years in the future, LEAPS provide market participants with a longer time horizon for their positions to play out.
Leverage: Like all options, LEAPS allow investors to control a larger amount of the underlying asset with a relatively small capital outlay.
Limited Risk: The maximum amount an investor can lose when purchasing a LEAP option is the premium paid, which can be considerably less than buying the underlying asset outright.
Flexibility: LEAPS can be used for a variety of purposes, including hedging long-term holdings, diversifying a portfolio, or speculating on long-term price movements without the need to invest in the asset directly.
Slow Initial Time Decay: In the early stages of a LEAP'S lifespan, the time decay (theta) is generally slower than that of a short-term option. That means the extrinsic value diminishes at a slower pace, initially.
Potential for Lower Implied Volatility: In some cases, longer-term options exhibit lower implied volatility than short-term options, leading to potentially cheaper premiums relative to the amount of time associated until expiration.
Cons of LEAPS Options
Higher Premiums: While they offer a longer timeframe, LEAPS usually come with higher premiums than shorter-term options because of the added time value.
Reduced Liquidity: LEAPS can be less liquid than standard options, which might result in wider bid-ask spreads. This can increase the cost of entering and exiting positions.
Exposure to Time Decay: As the expiration date approaches, the time decay of a LEAPS will accelerate, eroding its extrinsic value more quickly.
Dividend and Voting Rights: Holding a LEAP option doesn't grant the holder rights to dividends or voting rights in the company. Only by exercising a LEAPS call and purchasing the underlying shares can one access these benefits.
Complexity: For novice investors, understanding and managing long-term options can be complex. Factors like changes in implied volatility or interest rates can affect the value of these options more significantly.
Potential Underperformance: If the underlying asset doesn't move as anticipated, or if it moves very slowly in the desired direction, a LEAPS option may underperform as compared to a direct investment in the underlying asset.
