What are LEAPS?
In one line: LEAPS (Long-term Equity AnticiPation Securities) are option contracts with expiries a year or more away, priced with a lot of time value and used, among other things, as the long leg of a poor man's covered call.
How it works
LEAPS are ordinary options with a long life. They expire a year or more out, often in January, and work like any other contract: same Strike price, same Contract multiplier, same rights and duties.
What changes is the price. A long expiry means lots of time for the stock to move, so the time value is large. Two effects follow:
- Decay is slow. Theta is small per day when expiry is far away. The steep part of the decay curve is still many months off.
- Vega is big. A change in Implied volatility moves a LEAPS price much more than a short-dated option's. See Vega risk.
Sellers mostly meet LEAPS in one place: the Poor man's covered call. Instead of buying 100 shares, you buy a deep-in-the-money LEAPS call and sell short-dated calls against it. The LEAPS stands in for the shares. It costs less than the shares, but it isn't the shares, and that gap is where the risk lives. The wheel strategy in its plain form uses shares, not LEAPS.
An example (hypothetical)
An illustration, not a trade idea. Made-up stock XYZ trades at $50. A 14-month $30 call (deep in the money) costs $23.00, so $2,300 for one contract. Of that, $20 is intrinsic value and $3 is time value.
| XYZ after 12 months | LEAPS value (about) | Result on the LEAPS | 100 shares bought at $50 |
|---|---|---|---|
| $65 | $35.50 | +$1,250 | +$1,500 |
| $50 | $20.80 | −$220 (time value melted) | $0 |
| $40 | $11.00 | −$1,200 | −$1,000 |
| $28 | $0.50 | −$2,250 (nearly all of it) | −$2,200 |
The LEAPS loses money in a flat market, because its time value melts away. And below $30 it's worth almost nothing, while shares would still be worth $2,800. The cheaper entry comes with a floor at zero.
Why it matters for sellers
LEAPS tempt sellers because they cut the capital needed to run covered calls. That's real. So are the costs:
- No dividends. A LEAPS holder isn't a shareholder.
- Time value still melts. Slowly, but on a $23 call, $300 of time value is $300 you must earn back from short calls.
- Wide spreads. Far-out expiries trade less. The bid-ask gap can be large; use limit orders.
- Assignment on the short call means delivering shares you don't own. Your broker handles it, often by exercising your LEAPS, which throws away its remaining time value.
A sound check before buying one: write down what the LEAPS is worth if the stock is flat at its expiry. If that loss plus a bad month on the short calls is too much, use shares or stay smaller.
Questions
What does LEAPS stand for?
Long-term Equity AnticiPation Securities. In practice it just means an option that expires a year or more out.
Do LEAPS decay?
Yes, slowly at first. Time value melts faster as expiry gets closer, the same as any option. A deep-in-the-money LEAPS has less time value to lose than one near the stock price.
Are LEAPS a good replacement for shares in a covered call?
They cut the cost, but they're not shares. No dividends, time value that melts, a value that can go to zero below the strike, and wide spreads. See the poor man's covered call page for the full trade-offs.
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