Thursday, November 6, 2008

Leveraging With LEAPS

Leaps are simply very long term options. An investor can use Leaps to leverage on a given stock. For example, let's look at Intel (INTC):

Last trade: $13.87
Jan 2010 12.50 calls: $3.90

The 12.50 calls are "in-the-money" as their intrinsic value is $13.87-$12.50 = $1.37. This can be viewed as the cost of the call being only $3.90-$1.37 = $2.53. If an investor believes that INTC will be trading above $12.50+$3.90 = $16.40 then this investor will make a profit by buying the LEAPS.

Furthermore, if the stock appreciates beyond $17.40, the investor will be better off by buying the leaps. The ROI is shown on the chart and tables below.

(Please click on image to enlarge)

Clearly, the investor will maximize his or her profits with the Leaps. However, in case the stock does not go up in value in 1 year and 2 months till expiration the investor could lose all the investment.

2011 LEAPS

The chart below shows the same study (for ROI) for the Jan 2011 15 LEAPS, which today traded at $3.65 (12.50s are not yet available for Jan 2011):

Note that the break in for profit for the leaps is now $18.65, and the strategy will be more profitable than buying the underlying stock if the price goes above $20.35, a higher price, but we now have 2 years and 2 months to wait.That, for solid companies such as Intel, is a long time.

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