How Much Should You Pay for a LEAPS Option?
How much should I pay for a LEAPS option?
I often get asked this one question.
And the answer is pretty simple, but first let’s talk about what LEAPS are.
A LEAPS option is a Long-Term Equity Anticipation Security. Simply put, it’s an option that can expire in a year, two years or three years.
Why should you use a LEAPS option?
Well, it’s a proxy for the underlying stock that allows you to participate in the stock’s movement for a fraction of the price – over a longer period of time.
Which stocks should you buy LEAPS on?
I buy LEAPS only on non-dividend-paying stocks that I expect to appreciate. And I can use the same thinking for the downside. If I think the price of a stock is going lower, I will buy a LEAPS put option.
Now let’s talk about the pricing.
First off, you want to buy LEAPS with strike prices as close to the money as possible, meaning that if a stock is trading at $30, you want the strike price to be as close to $30 as possible.
Now, that option can be pretty pricey depending on the stock. So my formula for one-year LEAPS is to pay around 10% of the strike price.
For example, if the $30 strike of XYZ is trading for $3 or less, then I would buy that strike. If it’s more than $3, I would look to the next strike. If that strike is too far from the current price or not within a realistic target, I would either skip that trade or use a spread.
If I think the shares will move 20% in a year, from $30 to $36, the $3 I pay for the $30 LEAPS would go up 100%. The best parts of this trade are that I have a full year and my maximum loss is what I paid for the LEAPS, or 10% of the underlying price.
Now let’s say I wanted to go out two years. I would then pay 15% to 20% of the strike. Of course, the two-year target should also be substantially higher than the one-year target.
With LEAPS, you can close out the position at any time just like with a regular option. I use LEAPS in The War Room all the time. In fact, our biggest War Room winner came on a LEAPS play.
Action Plan: If you want real-time LEAPS recommendations, click here to follow me in The War Room!