Ep 164: Option Leaps: Long-Term Investing Strategies + Examples

December 7th, 2017

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We're going to be focusing on option LEAPS - Long-term investment strategies to make more with less money.

Our key focus in this video is all about options. It's about taking your capital using options for longer-term investments. Can you still use some of these strategies and concept I share with you on a shorter timeframe? Entirely because of the power of leaps.

You'll have a few disadvantages, which I'll talk about in the video. But the goal here is if you're trading or investing in stock only at the moment, and you're holding things for six months, a year, to three years, I'm going to show you how to do that with less capital by trading options or option leaps.

You might be wondering, what are leaps?

Leaps are long-term equity anticipation security that's what the definition stands for as far as abbreviation goes. But really, what it comes down to is it's just a long-term option. It's holding things long-term.

What does the long-term mean?

Long-term can mean six months, a year, two years, five years. The standard definition is typically longer than a year.

Some disadvantages to trading option leaps

  • The higher total costs you're going to pay because there's more time premium baked-in.
  • Change in price makes you less money because you usually have a smaller Delta. Also, when you look at the setup of the spread, the volatility can also impact this. So that actual change in price usually makes you a little bit less money. It's not something that I worry about too much because you can tweak these options to where your Delta is a little bit more in favor of what you're looking for but in general, the change in price makes you a little bit less than if you buy an outright stock.
  • The bid-ask spread can also be a problem because you're going further out so they can be a little bit wider. You may need to play around on getting into these positions. You don't have to get into these positions right away. You could get into them one to four days later because you're looking for longer-term holds.
  • The volatility can shift and create an issue with the position. This could be a volatility inversion, meaning you're on the wrong side of volatility because options are priced in part due to volatility. If you get in on a spread and the volatility goes against you, even though the price is going in your favor, but volatility is going against you, you're losing a little bit of money.

There are ways to counteract that as you get more into advanced options strategies and learn more about options.

Let's look at some advantages

  • It's a lower cost for the time you hold. If you have less capital, you get to make the same amount if not more with less capital.
  • There is less time decay when it comes to going further out. If you're looking at buying single option contracts or you're looking for precise movements in time or if you've been burned with time premium in the past with options, so there's less time decay that could be a good thing or a bad thing depending on the type of option trader that you are. If you're looking to capitalize for time decay, it's not a good thing. But you can still make some time decay from it. But if you're looking for movement and you need it to move, you don't have as much time decay. It doesn't work against you, but you can set it up to where it works for you.
  • There's a more extended life force the strategy to work which is why there's less time decay. Because there's less time decay, you get a longer lifeline for things to work out in your favor.
  • You can still make money from time decay when you're trading option leaps or longer-term options. It's just that usually you don't make as much.

You can use option leaps in all sorts of ways. You can use them to make some money from time decay. It can reduce your risk in the sense of using less of your capital to make more money, or you could use less of your capital to make the same amount.

Do you have to hold things all the way till expiration, let's say a year to three years later? No, you don't. You could hold the trade for a month. You could hold it for a day or two. It's really up to you depending on how long you hold the trade.

Keep in mind that there are also some problems that can occur like the volatility problem that it could put you on a little bit on the wrong side of the trade. Typically, if you're looking to hold a stock for a year or two years and it's not making you money, you'll probably get out now.

Yes, it makes you dividends with option leaps. Again, if you're holding it for six months to a year and it's not making you money now, you don't get the dividends, but you make a little bit on time decay.

Let me show you on screen some strategies with option leaps

How to set them up and what you're looking for. That way you can see how you make money with this rather than trading the stock. You could trade option leaps and hold on to stocks for multiple years without even getting into the stock.

Of course, you don't make those dividends. If you're a dividend investor which you can make money from the time decay, so it is the juggling effect depending on what pros and cons or what you're looking for your risk levels and your risk tolerance.

Let's go to the screen now the first thing I'd like to look at is some single options

Here we are on screen and what I'd like to do for you is to share with you some insight on a stock. Typically, you could do this with anything that trades options. But I like to prefer to do that with stocks over 40, 50 even a hundred dollars because there's more time premium baked thin.

If we go on screen here and we take a look at Amazon which is a vast stock. We'll buy, let's say 100 shares of stock, you're looking at a price of 1161. When you do this, and you go ahead and look for putting that trade on it's going to cost you around one hundred and sixteen thousand dollars okay that's the total for your trade.

If we look at analyzing this trade, you can see that using about a hundred thousand dollars for a delta of 100 - that means for every dollar move, the stock goes up. You make one hundred dollars.

If it gets to eleven seventy, you make about nine hundred dollars, and I'm doing this based on the mouse movement right there. As I move the mouse up and down, you can see the profit and the loss.

If we go into an option contract, let's say we go 40 days out and I'm looking for an option contract around $1300 as the strike price - go ahead by a single, analyze this trade. Keep in mind, and time decay is an issue and a problem when you're making single contracts. You're risking about $305 at expiration. That's the amount you're risking. You need the stock to move a couple of hundred points before expiration, and you could make $300-400. Of course, if it runs quickly even $1000 - 2000 at expiration but it needs to move that stock has to move really

As we look here on this panel and we start looking at evaluating this contract, that's one contract one hundred shares. I only have a delta of seven. So when you compare this to stock, you have a delta of a hundred. Whereas with an individual you have a delta of seven.

Can you increase the Delta?

Absolutely!

You could get a little bit closer. If you go in even tighter or closer to the current price, you got a twenty-six Delta.

Though I'm risking about $1695, not quite a $100,000 pretty much it's still a decent amount for a lot of people out there living off of a few thousand dollars a month. This could be a lot of money.

If we're trying to match up the same Delta here and we go to 100 Delta, let me make this about 25 Delta. Let's see if I could get it around 26 Delta is about as close as I could get. I'll need to trade about four of these to get a hundred Delta. Now I'm risking $5,620 to make almost $27,000 potentially.

If it happens right away today, I will make $26,000 at expiration.

If I compare this to the stock and I look at it this way - at $1,300 on the strike price, will make me $13,000 almost $14,000.

Here we make about 30,000 on or 26,000 on about 5,000 in the capital. So, which one's bigger? You're risking 5,000 to make 25,000 potentially, or you're risking a 130,000 to potentially make about 14,000 to make half of what's on the options.

You could see the power behind it.

The big issue is that option contracts are going to expire because every single day it costs you about a $128. You lose money every single day. This only continues to accelerate. It ramps up, it then becomes 135. You can see right there because we're just out about forty days. Again, continue to increase the date, and you're almost down three grand out of your five and a half grand. You're practically down half on your capital. Whereas with a stock, you could hold it for a long time.

What do you do in this case?

This is where option leaps come into play. This is the power behind them. If I go ahead and look and close down all these contracts, you can see you can get as far into options here in June, July, January. You can get the next year, and it's 500 days, 400 days, out 700 days out. You could get out quite a bit regarding time.

Let's say we're going till September 2018 - which gives me about 288 days

When we look at the option strike prices, we could still do 1300. It's going to cost you a lot more because look at this, it's $63 per contract, whereas the 40-day premium or the 40 days out is going only to be $2 a contract because there's more time premium baked in.

Look at the price difference - 94 versus 13. That's huge.

When we look at it for contracts, cost me 5300 for the January 18 which is only about 40 days out. If we go into a leap, it's going to cost me about $37,000. So, a lot more money but it's still not $116,000 as you would be with a stock.

Keep in mind. Our Delta is much higher. The Delta here that we have is 191, so you don't need as many contracts. We can just make two contracts to get the hundred Delta, and that'll put us only at 18,000 dollars in capital that we need.

so still more capital about eighteen thousand 19,000 capital compared to five thousand dollars in capital so about three and a half three point two times more in capital

Again, if you look at now your Delta, it's still roughly about a hundred, but your theta drops to 41. You're still losing $41 per every day but it's not 128 dollars every single day.

You get to save more money by holding these a little bit longer.

So again, if the stock gets to 1300, what's going to be your profit?

You're looking at about $1600 in profit.

You're not going to make as much as the 40-days out because merely because of the Delta effect the contracts, the volatility. All those things and you're using more capital, but you have less time premium risk.

As you start getting into verticals, this is where the power becomes with options.

On a vertical, I'll go ahead and buy a vertical. Analyze the trade again. We're 43-days out on this one and what we'll want to do here is we'll go and let's say we still project somewhere around 1300 but I'll go ahead and do the vertical something like this.

This puts me current prices at 1160. The vertical is that 1250 and 1220.

Here's the nice thing about verticals is you reduce that time value, time premium. Again, you're down to 10 now the Delta is only nine. If I want to bump that up to about a hundred. I'm using the capital around $5000.

My potential here is $50,000, but I need the stock to move. Your theta is still around a hundred and thirteen, so one hundred and thirteen per day, so you're still losing money per day on this vertical. It's not a significant difference on the stock.

What's the big advantage to this though?

You lose a little bit less but as this gets in your favor because you have a delta that picks up and a theta that actually works positively for you.

You can see that white line which is the current line or today's line gets closer and closer to the green line. The green line is the line at expiration.

In this case, I don't think stocks are going to explode to the moon all the time. I think they're going to move, but I don't think they're going to move to an extreme level.

A basic level is why we cap it because this reduces our risk on the time decay in the theta and then the theta then becomes positive as we get into that favorable more position.

Now, could I go ahead and sell put verticals instead?

Absolutely!

I could go ahead and sell put verticals and be more positive theta. That's another approach but keep in mind that we're still in January and we still have that time decay.

If we look at this, we bring the date back to today. We carry the price back to our price, and our Delta is right at a hundred. I'm using about $27,000 in the capital.

As you go further out in leaps, you're using more capital because there's more time premium baked in. But look at my theta, it's only 16 per day rather than 130 on the other one on the single. When you look at the single 130 or 113 on the other shorter term vertical, you're down to 16. So it reduces that theta even more so and you still have your hundred Delta.

Can you make more with a shorter term option?

Yes, but the time risk is against you. You can use less capital, but you have less time.

If you're looking for making money with the theta because once it gets into here, my theta is positive 13.

As I continue to move this date, it becomes 14. We get into 30 per day then we get into June you're up at $60 per day. On the theta, you're up to 133 thetas per day. That's from time decay.

Imagine you're getting a $133 per day from that option contract which is probably going to be way better than a dividend on the number of shares that you could buy for $27,000.

That's the power behind it. You're making twenty-seven thousand dollars on twenty-seven thousand dollars by June or July with using a lot less capital and risking less on the time premium.

That's one good way of looking at it. You can see that you can hold on to the stock for an extended period without having that option time value problem.

Can I get into this use twenty seven thousand dollars and let's say this stock starts to wiggle around a little bit wiggle around and I'm starting to lose money on theta and I'm down about let's say three hundred dollars I could just get out of it right then and there and say hey something doesn't look right it's starting to sell off an amount that's another approach you could take now.

If you're a longer-term investor, you probably don't do that. In this case, you could have a much wider pullback to 1,100 or even 1,000 and then allow that stock to continue to run in your favor because you have the time value.

You might not be so hot or interested in the fact that you're still losing money on theta but what you could do is you can convert this vertical that you're getting into the calls. You could go ahead and sell the puts so you could go ahead and sell a vertical here on the put side. Now, you'll be positive on the premium.

Do you want to use more capital and have no time decay, where time decay works in your favor or do you want to use less capital but time decay works against you?

You could do a split position here, and you could do something along the lines of getting in the middle.

In this case, you're using less capital. You're using maybe only four thousand in capital to make two thousand potentially. Let's bump it up, so our Delta is still a hundred or right around a hundred. The problem is when you go further out remember time decay doesn't help you as much, it is in your favor. If you're a buyer of an option, but here you're a seller of options, so you only make 18 on the theta.

You're still in a favorable position. You can have that stock going down so you could even do leaps. In this case, you don't make as much still. You're still using about fifty thousand and capital but that time decay works in your favor. You could make still twenty-four thousand dollars as long as that stocks above the 1085/1080 level at expiration.

If you're looking for long-term, you're making seventeen dollars a day just like a dividend still using about fifty thousand capital to potentially make about $24,000.

You can see how this continues to move in your favor because generally for long-term investing, you're bullish.

You can do the same thing with splitting things if you're a little bit more. Let me balance the time decay versus the risk, so again let's do a vertical. What I'll do is I'll split it right in the middle of where the current price is,

You can see I'm right in the middle.

If I want that hundred Delta bump up the contracts, I'm a fifty-fifty vertical, so I'm risking about 40,000 to make about $40,000/37,271.

You could see my time decay though because I'm almost right in the middle on that Center peak. I still need the stock to move in my favor with time, but I have till September for it to do that.

If I did this with contracts that are more recent, let's say in January, the issue here is now the time decay at the moment it works in my favor. But if this drops down, you can see I'm losing 190 right away. Whereas on September's, if this drops down, you're only losing nine dollars every day.

Again, time decay works in your favor, but it doesn't help you much. If it moves in your favor, you only make eleven dollars a day on the September and then on the January you would make 156. You'd make more in January because the time decay is going quicker in the current month.

Trade-offs where do you want to be.

Now, this is tomato-tomahto depending on your risk-to-reward. There's one last kind of strategy, I want to show you again with a long-term leap when it comes to options, and if we go here, it's called the Diagonal.

You can see this is kind of a bullish position as I look at this. You still want the stock to go in your favor. You're risking about $1700 in capital to make $2000 in capital potentially.

If you want the Delta to be about a hundred again, we'll make about seven contracts. You have time decay that works against you initially but what happens is as it moves in your favor, time decay will slowly become more favorable actually for you.

In this case, with what's happening - you're still risking about 11,000 to potentially at the peak make about 15,0000. This is not necessarily the best approach because what can happen is it overshoots your stock and you're losing money. So it needs to land there at expiration.

Can you take it off sooner?

Yes, absolutely.

What you can see is the time decay. The 10th is wider as well but the time decay also works in your favor. Your spread is 1100 to almost 1500. It needs to land somewhere here at expiration.

Whereas, the other one, you only have the spread between 1200 and almost 1300. You could see this is much much wider.

What you can do is the time decay since it's working in your favor. It continues to get closer and closer to that green line so as we get into March/April. You could see that time decay also builds.

My Delta, as I started out, was only 23 on seven contracts. You'll need to trade a little more if you continue to do a calendar.

The great thing about diagonal is we can rotate it by trading fewer contracts. Instead of 1260, which identically makes a calendar, I could go to 1240. You can see how it turns a little bit and increases my delta.

You can see how it's like a vertical. It's starting to come into more like a vertical.

There's a lot of advantages/disadvantages diagonals versus verticals that are beyond the scope but I'm trying to show you that for a long-term bullish investor, how you can still trade option leaps and you can see how you can do it with this one by just skewing and adjusting some things and the deltas close to 100. I could increase the contracts right there, and now I'm at a positive Theta. I'm risking about $47,000 to make $50,000 potentially.

Similar to a vertical, my theta is $14 a day at the moment. I do have a favorable Vega position in this case, whereas the vertical is usually a negative when you're doing verticals.

How can you skew this and adjust it?

I could move this back a little bit and let's say I go to 1090, and then I go drop this down to also 1180, and you can see I moved it a little to the so now I'm in more of a safe zone.

This reduces my Delta a little bit so I may need to trade a bit more contracts. If I wanted the same comparison, but you can see that even if it doesn't move, I make a right amount of money. If it moves up, I make money not as much as if it stood where it was because it descends a little bit.

But even if it moves down a little bit, I'm still somewhat protected for about a hundred points.

For long-term investors who are bullish because you're buying stock, this is again another approach. When you go into diagonals, you could see how I could skew it and rotate it and just shift that perspective from them rotating one way or the other.

Let's go into 1060, and you'll see the rotation. You can see that rotation happening. It depends how much risk-to-reward you want to play with. This is really what it comes down to - playing with these numbers and looking at these variations, the Theta, the Gamma, the Vega, the Delta, and how many contracts you want to trade.

I could go ahead and trade fewer contracts, but I could rotate this much more and increase it by the rotation rather than the contracts.

That's the power behind it. When you look at some diagonals, and you still make money like a dividend. If this thing stands still because you have that you and Theta make later on as it gets closer and closer to that expiration.

As you get into four or five months later, you make $50 a day, and a lot of it could be just from time decay on your capital. Of course, this does require around $40,000 in the capital, but you're making quite a bit even if the stock doesn't move.

For a longer-term investor who trades dividends typically or if you want to play the more significant stocks, this is how you do it.

 

Author: Sasha Evdakov

Sasha is the creator of the Tradersfly and Rise2Learn. He focuses on high-level education speaking at events, writing books, and publishing video courses on business development, internet marketing, finance, and personal growth.

I'm Sasha, an educational entrepreneur and a stock trader. In addition to running my own online businesses, I also enjoy trading stocks and helping the individual investor understand the stock market. Let me share with you some techniques & concepts that I used over the last 10+ years to give you that edge in the market. Learn More

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