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What is the difference between a LEAP and a regular option?

What is the difference between a LEAP and a regular option?
Asked by
Walter Peters categorie-icon time-icon6 months ago
1 Answer Answer Question

Sheila Olson
Answered time-icon6 months ago

The main difference between a LEAP (Long Term Equity Anticipation Securities) and a ‘regular’ option is the period of time until the expiry date.

Regular (Exchange Traded Options) have monthly expiry dates which are usually the third Friday in the month. You could for example buy Put options in a particular instrument with a Strike price of $125 and an expiry date in:  June, July, August or indeed any month in the next 12 months.

LEAPs are specifically intentioned to have expiry dates in excess of 12 months and in fact offer expiry dates up to 3 years away.

The difference in structure follows through to price action. An option that has an expiry date that is further away allows more time for the price of the underlying instrument to move towards the Strike price. In general, longer dated options tend to be priced at higher levels than shorter dated options and accordingly with LEAPs the premiums involved in buying them are higher than for regular options.

Rolls

The benefits of LEAPS are that traders can take option positions without having to ‘roll’ positions. If you were trading regular options and wanted to gain exposure to an expiry date in 18 months’ time, you’d need to take a position in the longest dated option available to you, which would likely have an expiry date 11 months in the future. In about seven months’ time you may see the option with the expiry you desire come into the market. At that point you could sell the first position and buy the next one. This rolling of the position will be subject to frictional costs and operational risk.

Capital & Hedging

LEAPs are similar to regular options in that both instruments offer possible advantages in terms of capital use and hedging. The longer term nature of LEAPs means they can more readily take advantage of these features, or at least mean the position does not involve further management in terms of ‘rolling’.

Taking a position using either instrument allows the position to be financed via the means of option premium being paid. If the position was bought outright then the entire cash balance would need to be financed.

If the LEAP/Option position is being used for hedging purposes, then taking on a LEAP is particularly advantageous as it means the operational risk associated with rolling is avoided. Buying existing and selling a new position although carried out at the same time could be subject to one trade getting executed and the other not, or possibly more likely the ‘fat finger’ risk involved with data entry.

Both LEAPS and regular options can be sold at any time; there is no requirement for them to be held until expiry.

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