What are LEAPs?

Long-term Equity Anticipation securities, or LEAPs, are equity, index and sector options with very long expiration terms. They were created by the Chicago Board Options Exchange (CBOE) to offer an alternative for investors with long term investing strategies.

The CBOE offers a comprehensive selection of LEAPs. Index LEAPs are available for major US indices such as the Dow Jones Industrial Average, S&P 500 and Nasdaq 100, as well as international benchmarks covering markets in China, Europe, Japan and Mexico. Similar securities for industry sectors have also been introduced, covering banking, oil services, telecommunications, healthcare and other important elements of the economy. Equity LEAPs are available for individual companies. Details on current offerings can be obtained from the CBOE.

Like traditional options, these securities give the holder the right to buy or sell the underlying asset at an agreed upon price over an agreed-upon period of time. While traditional equity options are available with expirations ranging from one to three months, these securities have terms extending out as far as three years. Both put options and call options are available. Index LEAPs are generally European-style and can only be exercised at expiration. Equity LEAPs are generally American-style and can be exercised at any time prior to expiration.

LEAPs can be priced using Black-Scholes pricing models and can be traded using the same strategies as more traditional options. Investors can purchase put LEAPs to protect long term stock positions or purchase call LEAPs if they expect a long-term bull market. Spreads, the simultaneous buying and selling of options at different strike prices, can also be implemented with this type of security, as can strategies designed to profit from changes in market volatility.

The long expiration term of LEAPs does introduce some complexities. They are highly sensitive to interest rates, which are likely to change over the life of a LEAP. In a rising interest rate environment, for example, put LEAPs can actually trade with a negative cash value. This is especially important for equity LEAPs, as there is a strong incentive for holders to choose early exercise.