Personal Business: Smart Money
A LONGER-TERM OPTION IN OPTIONS
Investors who dabble in equity options may find they're right about where a stock's going but wrong about when. Conventional options last a few months--not much time for a big move. But more investors who want extra breathing room are buying Long-term Equity AnticiPation Securities (LEAPS). Since their debut in 1990, LEAPS have become the hottest options product. The five U.S. options exchanges offer LEAPS on 150 stocks, with more on the way. They're also launching LEAPS on every major index, including the Standard & Poor's 100.
Like all options, LEAPS can be used for gung ho speculating as well as for protecting profitable positions. And their longer lives--up to 2 1/2 years--help avoid the common mistake of choosing an option that expires too soon.
MORE BANG. In the most popular strategy, you purchase a long-term call option. That's bullish, since calls confer the right to buy stock at a set price and time in the future. Buying the call rather than shares provides more bang for the buck--and more risk of losing the investment.
For example, a LEAPS investor would have paid $900 six months ago for the right to buy 100 shares of Compaq Computer at $55 per share in January, 1995. At the time, Compaq was selling for $48.50, so 100 shares would have cost $4,850. By mid-February, Compaq was trading at $92.50, nearly doubling the stockholder's money. The LEAPS call, meantime, had soared to $4,000, for a better than fourfold return. But had the stock plunged, the stockholder would have retained some value in the shares, while the LEAPS investor would have lost all $900.
GOTCHA COVERED. In another strategy, an investor who already owns a stock sells LEAPS call options on it. By pocketing the price, or premium, which tends to be higher for LEAPS than conventional options, the investor can still make money even if the stock remains steady or declines a bit. But if the stock takes off, writing covered calls, as that technique is known, puts a limit on profits.
For those who think a stock price is heading down, selling the call without owning the stock may be tempting. Writing uncovered calls takes maximum advantage of leverage and could provide an immense return if the stock collapses. But if the price soars, disaster strikes. Bears would do better to buy LEAPS puts, says Harrison Roth, senior options strategist at Cowen & Co. Should the stock rise, investors can't lose more than they pay for the puts, which confer the right to sell the stock at a certain price.
Steeper premiums mean a one-year LEAPS costs about twice as much as a three-month option. And LEAPS aren't available on many attractive stocks. But that's changing as securities markets continue to roll them out.TABLE: A LOOK AT SOME LEAPS
Strike Call Put Stock price
LEAPS* price premium premium (Feb. 18, 1994)
AT&T $55 3 3/4 4 1/2 53 5/8
MERCK 30 5 1/8 2 32 7/8
MORRIS 60 3 3/4 6 1/2 57 7/8
*Expires Jan. 20, 1995 DATA: COWEN & CO.