Long-Term Options Plays: Mohawk, Whole Foods

This was originally published on RealMoney. It is being republished as a bonus for TheStreet.com readers.

You don't often hear the terms "value investing," "fundamental analysis" and "equity options" used in the same sentence. That's because stock options are speculative in nature; they have definite life in which your bet has to play out. In addition, time is not on your side when you buy options, whereas, with stocks, time is an investor's best friend.

Nonetheless, with so many great businesses getting clobbered because of the sloppiness of some of the financial institutions, an investment via long-term options, or LEAPS, can offer a compelling bet: little upfront capital with the possibility of huge gains. But since you are getting involved with a decaying financial instrument, LEAPs should be used on only the most compelling investment ideas.

LEAPS, or long-term equity anticipation securities, are long-term options on a common stock. Generally, LEAPS have a duration of two years, but sophisticated investment firms can create longer-dated LEAPS.

The appealing quality of LEAPS is obviously the length of time imbedded in the option. The common mistake that investors make with options is not a matter of making the wrong call but rather not having enough time in the option to allow a strategy to play out.

LEAPS provide the investor with sufficient time, so that usually is not the issue. Two years should be sufficient time for any business to regroup from most operating environments. The issue to consider when buying a LEAP sits squarely on the underlying business.

Invest, Don't Speculate

The use of LEAPS is most prudent and successful when it is most businesslike. The primary advantage of buying LEAPS vs. the outright stock is of course the capital that is required. Buying LEAPS requires a fraction of the capital needed to buy an equivalent amount of stock. Yet the disadvantage of owning LEAPS vs. the stock is that if your analysis is wrong, then you could lose 100% of your capital. So use LEAPS only when the odds of success are skewed heavily in your favor.