Gregg Greenberg
I am a new investor and I am trying to sort everything out. Could you please explain what "Leaps" are? Thank You, W.K.
Long-term Equity AnticiPation Securities, or LEAPS, are option contracts that allow investors to establish positions that can be maintained for a period of up to three years. Why would an investor want to get bogged down in a three-year commitment? Well, let's first take a look at the basics of options before leaping into LEAPS. Options allow you to make a bet on the direction of an underlying investment such as a stock, bond or market index without actually buying that investment. There are countless ways investors carry options -- from using them as a hedge to avoid a big loss in a stock to making very risky bets that a stock will rise or fall -- but they revolve around two simple choices: options to buy and options to sell. An option to buy is known as a call; calls are bought when investors think the value of the underlying stock is going to rise. Here's how a call works: An investor pays a premium, which represents a fraction of the value of the underlying investment, for the right to buy a stock at a preset price, known as the strike price, within a given time frame. After buying the call options, you have two choices. Let's give an example to make it clear what happens with the money. We'll say you bought 10 call options for 100 shares each of XYZ Co. for a premium of $500. The stock's price was $35 a share when you bought the option, and the strike price is $40. The options in this case expire in three months. Hold the options until maturity (the day they are set to expire), then trade them at the strike price: If the stock is above the strike price, you make money if the difference exceeds your premium. So, if you exercise the option to buy the stock at $45 a share, the 1,000 shares would be worth $5,000 more than the strike price. Subtract the $500 premium, and you made $4,500 (minus fees you pay to your broker). You also have the option to trade the options before it expires, if you're happy with the profit at the time. Say the stock stays at $35 the whole time, or drops lower. It wouldn't make sense for you to trade the options, because you would lose thousands of dollars. So, you let the options expire and all you lose is your $500 premium.
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