Equity LEAPS Puts

Definition

The term equity LEAPS put refers to the investment strategy involving the buying of a Long Term Equity AnticiPation Security when a stock is thought to decrease in price.  Equity LEAPS puts 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 owns common stock in Company ABC and is unable to sell it due to the sensitivity of the position they hold in the company.  This individual has a considerable amount of their portfolio invested in Company ABC and would like to purchase a LEAPS to hedge against a loss.

The investor owns 20,000 shares of Company ABC common stock, which is currently trading at $100.00 per share.  A three year 90 LEAPS is trading at $5.00.  Buying the 90 LEAPS provides the investor with the right to sell this stock at $90.00 regardless of how low the stock's price falls.  The investor decides to purchase 200 puts for a total of 200 (puts) x $4.00 (price) x 100 (multiplier), or $80,000.

If the price of Company ABC's stock declines to $85.00 over the next 12 months, the LEAPS will be in-the-money, and the value of these puts can be used to offset the unrealized loss the investor has on the Company ABC stock they own.  In this example, the value of the LEAPS is $5.25.  The profit on the LEAPS put would be:

= Sale Price of LEAPS - Purchase Price of LEAPS
= $5.25 x 200 (puts) x 100 (multiplier) - $80,000
= $105,000 - $80,000, or $25,000

Related Terms

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