Leap Option Strategy
What are the characteristics of this option strategy?
Leap Option Strategy (LOS) is a conservative debit spread strategy involving buying long-term out of the money (OTM) naked calls and offsets them with the sale of an equal number of out of the money (OTM) puts to finance the purchase. This strategy relies on expecting the underlying market to trade sideways over the course of the entire contracts expiry. The advantage of this strategy is that the investor can set up a long-term position that gives them plenty of time for the stock to move into the money. Different from the traditional option spreads, using the LOS does not require the investor to make any adjustments since it is a long-term passive strategy.
Is this a bullish, bearish or neutral strategy?
The LOS is a neutral to slightly bullish strategy. The purchase of long-term OTM calls gives the investor limited upside exposure, while the sale of OTM puts protects him/her down to a certain level. If the underlying asset stays above the strike price at the time of expiration, then the investor earns the full profit.
Is this a beginner or an advanced option strategy?
The LOS is considered an intermediate option strategy. It requires a good understanding of options pricing and the ability to assess volatility of the underlying stock.
In what situation will I use this strategy?
The LOS is most suitable for investors who expect the underlying stock to remain relatively flat for an extended period of time. By investing in LOS, investors can take advantage of the long term positive Theta and positive Delta from being long a call.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The risk-reward of the LOS is highly dependent on the underlying volatility of the stock. If the stock volatility is low with a long-term consolidation pattern, then the probability of profit is higher with a lower risk. If the stock is more volatile, then the probability of profit also increases but at a higher risk.
How is this strategy affected by the greeks?
The LOS is affected by Delta, Theta and Vega. Delta measures the rate of change of the theoretical value of the option with respect to changes in the underlying stock price. Theta measures the rate of change of the options theoretical value with respect to time decay. And Vega measures the rate of change of the option theoretical value with respect to changes in volatility. Overall, the purchase of long-term OTM calls and offsetting with the sale of OTM puts will result in a positive Theta and positive Delta.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The LOS is most optimal when the VIX level is low, below 20. The lower the VIX, the lower the volatility and the lower the cost of the option. This means that the investor can maintain the long-term position for a longer period of time without having to adjust the position or purchase new options.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
Adjusting the LOS when the trade goes against me can be difficult. Since it is a long-term strategy, the options will have a lower time to expiration, resulting in a shorter time to adjust the position. One way to adjust the strategy is to buy back the long put option and replace it with a longer-term put option at a higher strike. This will allow the investor to increase the probability of profit and also increase the Delta benefit from the long-term OTM call.
Where does this strategy typically fall in the range of commissions and fees?
The commission and fees associated with LOS will depend on the brokerage and services they provide. Usually, brokers offer a tiered commission structure which will be cheaper when the size of the order increases. The total cost of a LOS trade can range between $20 to $50.
Is this a good option income strategy?
Yes, the LOS can be an effective option income strategy. Since it is a long-term passive strategy, it can provide a steady stream of income as the underlying asset stays within the strike levels of the options.
How do I know when to exit this strategy?
The optimal time to exit a LOS trade is when the underlying asset hits the strike price of the long-term OTM call and the put option is near expiration. This is generally an indication that the stock will remain within the strike levels of the options and the investor can then exit the trade with maximum profits.
How will market makers respond to this trade being opened?
When market makers respond to a trade being opened, they will usually adjust the bid and ask prices to attract buyers and sellers. They will be looking to match people who are buying and selling the same option contracts to guarantee the best price execution.
What is an example (with calculations) of this strategy?
Let’s consider a LOS strategy involving the stock of XYZ Company at $50/share. An investor can buy 1 XYZ $50 call expiring Jan 21, 2023 and offset the cost of the option by selling 1 XYZ $50 put expiring Jan 21, 2023. Assuming the XYZ Jan21’23 $50 call and put option are trading at $10 and $7 respectively, the cost of the LOS will be $3 ($10 – $7) per option contract. If XYZ stock trades above $50 at the expiry of the options, the investor can earn $11.50 ($14 option premium received from the sale of the put option less the initial cost of the LOS at $2.50) as profit.
Where does this strategy typically fall in the range of commissions and fees?
The commission and fees associated with the LOS will depend on the brokerage and services they provide. Usually, brokers offer a tiered commission structure which will be cheaper when the size of the order increases. The total cost of a LOS trade can range between $20 to $50.
MarketXLS
Investors who are interested in options trading strategies such as LOS should research the options trading strategies available, as well as learn more about the risks involved. It is important to have a full understanding of options trading strategies before diving in and executing a trade. MarketXLS options trading platform is an excellent tool for options traders of all levels of experience. From beginner to experienced traders, MarketXLS helps users understand options better and
Here are some templates that you can use to create your own models
Call Backspread Option Strategy
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
What is the Risk Associated with Leap Options Investing?
Long-Term Equity Anticipation Securities – Leaps Options
Collar Option Strategy – A Synopsis
Collar Option Strategy – A Synopsis
Benefits of Being Delta Positive