Short on cash but want to cash in on that hot stock tip? LEAPS is a method of buying stock that can turn a small profit into a huge payday.
A LEAP is a stock option that you purchase at a discounted rate – and one with an expiration date typically greater than one year.
Let’s say you are certain that Apple stock is going to rise in the coming years. You check and find that Apple is trading at exactly $100 (for ease of understanding). You have $10,000 available and you’re ready to roll the dice.
You could buy exactly 100 shares and see what happens or you could check the Chicago Board of Options Exchange. You find a call option expiring in a year and a half and it has a strike price of $105.
You can go ahead and purchase at this price by simply paying the listed premium – a fee for the right to purchase. Let’s say the premium is $3.00 per share.
LEAPS are sold in contracts of 100 shares – easy enough to calculate with our $100 price in this example.
You take your $10,000 and divide by the premium, giving you 3333 and round down to the nearest 100 to complete the contract. You are now entitled to purchasing 3300 shares of Apple.
You’re entitled to buy Apple stock at $105 and you are paying $3 per share to exercise this right. To break even, AAPL will need to be at $108 when the contract expires a year and a half from now.
What happens if you make this purchase and Apple is sitting at $107.99 when the contract expires?
You lose all $10,000! LEAPS are not for the faint of heart. They require a great leap of faith!
This investment only makes sense if you firmly believe that Apple will be several dollars over $108 when the contract expires – and perhaps have some hard data backing your assumption. After all, you’re not interested in just breading even. You’re taking on a little more risk for a little more reward.
If Apple stock jumps to $120 before the contract expires, you could simply close out your position. It is at this time that you will be actually purchasing the stock for $105 and selling them for a profit of $15 each.
You just made $49,500 minus the initial premium (already paid) of $3 a share ($9999) for a grand total profit of $39,501.
Had you simply bought the stock outright at $100 and sold at $120, you would have netted a still respectable $12,000.
LEAPS Are Risky
The above scenario should make it perfectly clear that LEAPS are about great risk, great reward.. or losing a lot of money.
Unfortunately, the latter is usually the case. There are many stories of those who have made a fortune in the stock market using LEAPS but they’re usually the exception to the rule. The current Bull market could turn Bearish at any time.
LEAPS are for gamblers – and only those who can afford the risk. Never take a chance on money that you can’t be without in the future. It simply makes no sense.
Even with a strong performing stock from a company that has a bright outlook – such as GTAT, a stock price can decline at any given time and it can do so without any good reason. Such is the nature of the stock market.
If you’re a risk-taker by nature and simply looking to pay off your 30-year home loan a little quicker, you might consider taking a loan from your 401k as an alternative.