Equity LEAPS Calls

Definition

The term equity LEAPS call refers to the investment strategy involving the purchase of a Long Term Equity AnticiPation Security when a stock is thought to increase in price.  Equity LEAPS calls differ from standard options only in terms of their expiration, which can be up to three years in the future.

Explanation

Equity LEAPS provide investors with the opportunity to take a long-term position in the stock market without purchasing stocks.  They can also provide a hedge against a decline in value if the investor owns the underlying securities.  If an investor anticipates an advance in a stock over a long-term timeframe, they have the option of purchasing an equity LEAPS, specifically a call.  If the investor anticipates a decline in the price of a stock over a long-term timeframe, and they own the stock, they can hedge their loss by buying a LEAPS put.  In this manner, LEAPS can be used to lower an investor's loss of capital risk.

Example

An investor believes the price of Company ABC's common stock will increase significantly over the next three years.  The investor would like to participate in this increase, but does not wish to hold the stock in her portfolio.  Company ABC is currently trading at $100 per share and a three-year LEAPS call with a strike price of $99.00 is selling for $17.00.  The investor decides to purchase three of these calls for a total of 3 (calls) x $17.00 (price) x 100 (multiplier), or $5,100.  The LEAPS call provides the investor with the right to buy 300 shares of Company ABC's common stock at $99.00 regardless of how high Company ABC's common stock increases.  The breakeven point for this investment is calculated as:

= Strike Price of the Option + Premium Paid on the Option
= $99.00 + $17.00, or $116.00

If the price of Company ABC's stock rises above $99.00, the investor has the option of buying Company ABC's common stock at $99.00 or selling their in-the-money LEAPS.  If the price of Company ABC's stock falls below the call's strike price of $99.00, the investor loses the price paid for the three calls, or $5,100.

Related Terms

equity collars, protective index collars, equity LEAPS puts, index calls