Video #1 in our 4-part series, featuring Bryan Perry, Investing in LEAPS (Long-term Options) for Short-term Income.
VIDEO #1 TRANSCRIPT:
Roger: Hi, this is Roger Michalski, publisher of Eagle Financial Publications. Today, I’m here with Bryan Perry, editor of the Cash Machine newsletter and an expert on income investing. How are you doing today, Bryan?
Bryan: I’m happy to be here, Roger, thank you.
Roger: We’re happy to have you. Today, we’re going to talk about LEAPS, which are long-term options. They’ve been around for about ten years, but a lot of people don’t really know a whole lot about them, or how they can really be used as a great investment vehicle, so can you explain them to us?
Bryan: Sure. LEAPS is an acronym for Long-Term Equity Anticipation Securities. To put it bluntly, they’re really just long-term call options, or put options on very liquid stocks.
Within the past ten years, Roger, the LEAPS market has expanded dramatically, from just a handful of names, into what is now a widespread buffet table of heavy-weight names with a lot of different strike prices and a lot of different expirations that, even now, are not just once a year. Now, you’re seeing multiple expirations going out further than a year. That’s really a great benefit to those that are trying to understand the LEAP market.
What LEAPS do, primarily, is they act as a substitute for stocks. Stocks that trade above $100 a share are really what’s leading this market right now – names like Lockheed Martin, Home Depot, Amazon and Google. These are stocks that we want to be – as investors – a part of, but, in order to build a portfolio of those types of names, it would cost hundreds of thousands of dollars.
So, what the LEAP market offers is a way into owning a basket of the best names in the market – and we’re in a market where the $100 stocks are in charge. They are front and center, they’re center stage to where the market is paying attention to. That’s what the indexes are moving on.
Roger: You’re seeing stocks that are $600, $700 as a norm – it didn’t used to be that way.
Bryan: Right, well companies used to split these stocks more often than they do now, and stock buyback business is huge. That’s all a big part of what companies are doing here to maintain tight floats and keep their earnings up. At the same time, it prices a lot of retail and average investors out of that marketplace.
So, the LEAP market does offer a wonderful way for investors to cultivate a portfolio of between seven and ten really strong names at any given time, and have for a fraction of the cost what it would normally have to put together to own that portfolio. They can, without the use of margin, own and control a really great portfolio of the best crème-de-crème names of the market. And go out between nine months to a year and a half, and understand that build on the fact that you’ve got…if a large-cap stock that’s trading in around $250 a share makes just a 3% or 4% move, then the underlying LEAP is going to move somewhere between 10% and 15%, maybe 20%, depending on the stock price itself.
There is a feature in LEAPS called delta, and this is really important, because when we buy LEAPS, it’s the most intelligent way that an investor can trade the options market. We’re buying a lot of time, we’re giving the stock plenty of time to move, and we’re also what we call, buying in-the-money. We’re buying at the stock prices at $250, and we’re buying a LEAP that is at a $230 strike – we’re buying in-the-money – and what we want to do is hide delta with every trade.
If a stock moves a point, we want that option contract to move at least 80 cents to 90 cents. That would be a delta of 0.8 or 0.9. So, the higher the delta, the more the LEAP is correlated to the stock. What I try to do is put together strategies where there’s a high correlation of the LEAP to the stock itself. That means, buying in-the-money, buying plenty of time, so that the delta works in your favor.
And that’s really the beauty of it. It’s the kind of options trading that most people should consider before they run into the emotion of greed, and they want to shorten up their time. They want to go out-of-the-money, and then they usually end up losing money. And that’s why 90% of all options trades expire worthless.
Roger: Right, so what is the big advantage? A lot of people do short-term options, then there’s LEAPS, which are more timed with the advantage of more time.
Bryan: Well, more times where you don’t have to be as lucky. And, really, you allow the stock to endure the storms that come along and, knowing that if you’re in a secular bull market with a particular stock, you’ve got plenty of time on your side. That’s really the nature of buying a LEAP because it does control heavy-weight stocks – the 800 pound gorillas if you will – for a fraction of the cost, but for an extended period of time.
That’s really what options traders have to learn to have that personal discipline to do that. It really is very gratifying to have that because there’s always going to be things that knee-cap the market. If you’re running out of time or if your options trades are too far out-of-the-money, then, typically, that’s where people lose.
Buying in-the-money on LEAPS on the best names out there, and buying plenty of time, is how people win in the option market.
Roger: So, clearly, lots of ways to invest in LEAPS and advantages of LEAPS. And, Bryan, one thing we will get into in the next video is you have a strategy that will bring you instant income on these LEAPs, and we will talk about that in the next video. So, thank you everyone for watching this video. We look forward to seeing you in the next one.