LEAPS CALL OPTIONS EXPLAINED
Most buy-and-hold investors and index investors are not aware that LEAP calls can be used as a source of investment debt. Do you know that using LEAP call options is a little complex than purchasing stock on margin, but the rewards can be a lower cost of capital, higher leverage, and no risk of margin calls. The traveling Trader is here to demonstrate to you.
This tutorial for leap call options is on how to execute leap call options on your favorite stocks, that you think are going to be worth a lot more within two to three years. About stocks like NIO some of the cannabis stocks like PALANTIS, where you can almost foresee the true value in a couple of years like in my view there’s almost no way that NIO won’t be at least a hundred dollar stock and I will also give you some examples on an advanced financial service platform like Thinkorswim and Robinhood (these online platforms offers a mobile app and website that offer people the ability to invest in stocks, ETFs, and options) and on how to execute those orders.
LEAPS and LEAPS call options.
Long-term equity anticipation securities (LEAPS) are publicly traded option contracts with expiration dates that are longer than one year. As with all options contracts, a LEAPS grant a buyer the advantage, but not the necessity, to purchase or sell—depending on if the option is a call or a put—the underlying asset at the predetermined price on or before its expiration date.
For better understanding, What are LEAPS?, LEAPS are basically just long-term options and the term stands for long-term equity anticipation securities. They are just publicly traded options contracts with a forward-looking date and usually for a year or longer.
The difference in calls and puts:
A Call Option gives the buyer the right, but not the obligation to buy the underlying security at the exercise price, at or within a specified time. A Put Option gives the buyer the right, but not the obligation to sell the underlying security at the exercise price, at or within a specified time.
Equity—another name for stocks—LEAPS call options to allow investors to benefit from potential rises in a specific stock while using less capital than purchasing shares with cash upfront. In other words, the cost of the premium for an option is lower than the cash needed to buy 100 shares outright.
we’re just going to be covering leaps in terms of calls and not puts and a call option is basically a derivative of the stock itself so a call option. If we take an example of NIO. It allows you to buy 100 shares of stock per contract in the US stock market at a certain price. Usually, LEAPS are used to generate more cash rather than the intention of owning more stocks.
How to execute a LEAPS call option
A call option is a derivative that follows the stock itself and these derivatives also have a dollar value different from the original value of a stock(as per contract).so these options have a dollar value when you’re trading options you’re buying and selling them for a dollar value. so when we’re talking about call options are bullish derivatives, when you buy a call option you basically want the stock to go up (bullish) and the call options have the same bias as the stock itself so, when the stock goes up, when the value of the stock goes up in terms of dollars then the call options also go up and the reverse is true.
So if the value of NIO stock is X and leap call dollar value is Y. So when X goes up Y also goes bullish and when X goes down, Y also goes down.
So, firstly you are best off buying leaps or buying call options when the stock declines in value. Because then the call options will be cheaper so just because a stock declines in value in the short term doesn’t mean that your long-term outlook isn’t bullish.
Conclusion1: for long term growth, buy the leap call option during the retracement period that gives exaggerated discounts.
Conclusion2: The advantage with options is that your capital commitment is actually a lot less than buying 100 shares of the stock.
If we check out Robinhood. Currently, NIO is priced at 53.92USD let’s just call it 54.
So if you bought 100 shares of NIO it will cost you 5400 USD.
For example call options contract here the 50 contracts expiring December 24th cost you 8.75 USD
You will have to multiply this by 100 to get your cost basis.
It’s going to cost you 875 dollars for this expiry.
X*100= cost price for 100 stock
Y*100= cost price for Leap call
And X> Y
Conclusion3: The reason that options cost a lot less than the shares do is because of this time commitment. The stock has to move in the favorable direction of your option for you to make money and it has to do so by this date .so it is essentially like a bet almost and that is why it costs a lot less than buying the stock itself.
How much gains can we expect for the leap call option if NIO gains five dollars in its stock price? How much do you stand to make with your option? Now, this is where the concept of delta comes into the picture?
What is Delta? How to use it?
Delta means the amount of money that call option will gain based on a one-dollar move in the stock
Delta is represented as a decimal as a ratio. For instance that you have an option that has a 0.5 delta
That means for every dollar that the stock price goes up, the option will make 50 cents (0.5USD).so it moves at half of the value of the stock.
If delta is 0.5 when the stock price of X goes up to X+1USD. Then option will gain +0.5USD
Conclusion4: There is a general rule for leap call options that you essentially want to engage in
LEAPS that have a 0.8 delta and above. Because you want to mimic as close as possible the gains with hefty discounts on the cost price.
If we take an example for NIO
For the JAN 2022 more than a year out and obviously we
We want to buy neo for the long term but we don’t want to spend 5400USD on a hundred shares of stock. we would then look for a strike price that has a 0.8 delta or above.
Now we remember X for 100 shares = 5400USD
For NIO Delta the 40 dollar is almost 0.879. So let’s use this as our example.
So this has a point almost a 0.8 delta the 40 strikes.
Cost of NIO Leap call option for 1 shares would be = 40*0.879 = 26.65USD
Cost of NIO leap call option for 100 shares = 2665 USD
So instead of 5400 USD, we just have to pay 2665USD and we got to control 100 shares with 0.8 deltas.
That means that for every dollar that NIO moves up, this option will move up 80 cents so we get 80 of the stock movement but it’s only costing us half.
How to know the gains in the leap call option?
For example, if in the period of a year at some point neo ends up being 75 bucks right so let’s just say
NIO stock price is 75 bucks. That is from 54 USD to 75 USD
If we calculate profit for X, on the original cost of 100 stock without leap call,
Profit% = ((S.P-C.P)/C.P)*100
That is = ((75-54)/54)*100 = 38.89 almost 39
So 38.89 is the profit percent for stock if it goes up to 75.
Let’s check out the leap that would generate for the same move.
If NIO stock price is increased by 21, this leap has a delta of 0.8 delta which means that for every dollar that neo goes up in stock price, the option goes up by 80 cents so naturally a 21 move times 0.8 would mean that NIO moved up 21 times 0.8 means that the leap moved up 16.8 dollars.
So let’s add 16.8 to the 26.65
Now the moved up the price of NIO leap call would be= 16.8+26.65= 43.45USD
If we calculate profit for Y, on the cost of 100 stock with leap call,
Profit% = ((S.P-C.P)/C.P)*100
That is = (43.45-26.65)/26.65)*100 = 63
63 profit on the leap call versus 38 profit on the stock and it cost us half as much to get in.
Conclusion5: The power of leaps and options is, it has a leveraged factor because you can control 100 shares of stock with less capital investment.
That is the cost of X is higher than Y, but the profit for X is lower than Y.
Extra Keynotes2: Do you have to wait until expiry?? No, you don’t, you can sell it at any time and even if it’s up you could sell it for profit. If it’s down you could sell it for a loss and exit.
LEAPS call options with examples on PLTR stock (Planter stock)
An example on thinkorswim let’s just take Palantir for instance,
let’s just take the January 2022 calls, you can see that its current price is 27.66 and the deltas here is 0.8 delta will be at the 20 strike price.
On Palantir for 14.70 remember we have to multiply this by 100, so 1470USD to control a hundred shares of Palantir as opposed to paying 2766 USD which is based on the stock price and the same thing applies for every dollar that Palantir moves up in its stock that call option right there will move up 80 cents based on the stock movement.