LEAPS Options Strategy: Beginner's Guide

💡 LEAPS: Pro Takeaway

I don't love buying LEAPs. If I want to take a long-term bullish or bearish position, I'd rather not do it through a derivative that's perpetually shedding value.

For example, let's say you're bullish on ABC, currently trading at $75/share. You think that in one year, ABC will be trading over $100. You don't have the capital to buy 100 shares, but you do have enough to purchase a 100 strike price call option expiring in one year.

Trade details

• Current stock price: 75
• Strike price: 100
• Call option premium: 3 (or $300 per contract)
• Days to expiration: 365

Now, let's say ABC rallied $25 to $100 on the expiration of our option:

You can see the time element in action in the above chart. Even though ABC is increasing in value, it's not rising fast enough to offset the time decay in the call.

Had we just held the shares, we'd be up 25%. Instead, our call expired worthless and the premium vanished. Watching a stock inch up while your option bleeds value is nerve-racking. I've been there!

In this article, we'll cover everything you need to know about LEAPs—when to use them, how to set them up, how to manage them, and some go-to tips for making them work.

Outlook: When To Trade LEAPS

Here are a few scenarios where trading LEAPS may make sense:

1. Speculation: Make directional bets with more time for your trade to play out.
2. Capital Preservation: Control stock exposure with far less capital at risk.
3. Hedging: Buy LEAPS puts to protect positions or a portfolio from big drawdowns.
4. Income Generation: Sell LEAPS calls against stock you own to collect premium (covered calls and covered puts).

This article will focus on buying LEAPS as a speculative tool, though they can be used in many other ways.

Call vs Put LEAPS

A LEAPS option is an option contract with a more prolonged expiration, typically 12 months or more. There are two types of options:

• Call option: Gives the owner the right (but not the obligation) to buy 100 shares at the strike price.
• Put option: Gives the owner the right (but not the obligation) to sell 100 shares at the strike price.

And here are the basic payoffs of calls and puts:

If you’re new to calls and puts, start with our beginner-friendly guides below to understand how these strategies work, how risk is defined, and when they may make sense in your portfolio.

LEAPS vs Stock

There are several nuances where it may make sense to trade LEAPS over stock, depending on your risk appetite, market forecast, and capital allocation preference. Here are a few significant differences to consider:

LEAPS: SPY Call Trade Example

In this trade example, we are long-term bullish on SPY (SPDR S&P 500 ETF Trust), so we will buy a LEAPS call option expiring in about one year.

Before buying options on broad-based ETFs like SPY, check the VIX (CBOE Volatility Index). A higher VIX means higher option premiums, while a lower VIX means cheaper premiums. The VIX is currently trading off its year low, so it looks like a decent time to buy premium. 

Let’s head to the TradingBlock dashboard and find a call option that works for us on the SPY options chain. We’ll target a call option out of the money by about 10%:

The 725 strike price call is almost exactly 10% above the current price of SPY, 659.21. We can see this market in the highlighted green bar above. 

LEAPS are typically thinly traded. Always start at the midpoint between the bid and ask when trading options, especially LEAPS. If you don’t get filled at the mid, slowly work the order up in penny or nickel increments until you do. Read more about options liquidity here. 

We’re going to assume we bought this call at the midpoint, as seen below:

SPY Trade Details

So we bought a SPY call about 10% out of the money for $19.40. This means SPY must rally about 10% just to reach our strike. To breakeven, SPY must rise to the strike price plus the premium paid.

Also, notice the delta highlighted in the option chain above. Among other things, delta tells us the percent chance an option has of expiring in the money. In this case, a 0.30 delta implies about a 30% chance of expiring in the money. More on delta later. 

Here are our trade details:

• Current SPY Price: $659.21
• Expiration: ~366 days (about 1 year away)
• Buy 725 Call @ $19.40
• Delta: 0.30
• Net Debit Paid: $19.40 ($1,940 total)

And here is the payoff profile:

• Breakeven: 725 + 19.40 = $744.40
• Max Profit: Unlimited 
• Max Loss: $19.40 ($1,940 total)
• Chance ITM: About 30% (based on delta)

Let’s now explore two trade outcomes!

SPY Call LEAPS Option: Winning Trade

In this trade outcome, SPY rallied 15%, sending our SPY call option into the green. Here’s where we ended:

• SPY Price: $659.21 → $758.09 ⬆️
• Expiration: 366 days → 0
• Buy 725 Call @ $19.40 → $33.09 
• Final Value: Worth $33.09 at expiration
• Net Gain: $13.69 ($1,369 total)
• Return on Risk: 71%

That trade illustrates the power of leverage. Had we invested that $1,940 in SPDR S&P 500 ETF Trust (SPY) stock instead, our profit would have been about $291 (15%) compared to $1,369 (71%) on the LEAPS call.

Let’s next see how this trade played out:

SPY Winning Trade: Under the Hood

Here’s how our long call performed over the 366-day duration of our long call LEAPS option.

The first few months saw SPY slip about 2.5%, which sent our LEAPS call down nearly 60% as it moved further out of the money. This sharp early drawdown highlights how calls can lose value much faster than the stock itself. 

From there, SPY turned around and climbed steadily for the rest of the year, driving our call back into the green and ultimately finishing deep in the money.

SPY Call LEAPS Option: Losing Trade

In this trade outcome, SPY fell 5%, sending our SPY call option into the red. 

Here’s where we ended:

• SPY Price: $659.21 → $626.25 ⬇️
• Expiration: 366 days → 0
• Buy 725 Call @ $19.40 → $0.00
• Final Value: Worth $0.00 at expiration
• Net Loss: $19.40 ($1,940 total)
• Return on Risk: −100%

This shows the downside of leverage. SPY only fell about 5%, but our long call lost its entire value. Let’s next see what actually happened.

SPY Losing Trade: Under the Hood

This trade ended in max loss, costing us the entire premium. If we had invested the same $1,940 directly in SPY stock instead of the LEAPS call, a 5% drop would have only cost us about $97. This is the downside of buying options: you have to be right on direction, price, and time.

I like to use limit orders to take profits. Generally, if I can get around a 50% return, I’ll scale out of some or all of the position. In this case, we can see the LEAPS call hit about a 76% gain near the 186 DTE mark, well above my usual target.

But we didn’t take profits, and this shows how quickly gains can evaporate if you don’t lock them in.

Choosing Delta & Strike Price 

Before trading any option, I first look at delta. In options trading, delta is the option Greek that tells us how much an option's value may change given a $1 move up or down in the underlying asset. Delta also tells us:

• The number of shares an option ‘trades like’
• The probability an option has of expiring in the money

Since you want your option to be in the money on expiration, you probably don’t want to buy a call or put with a delta below ±0.10, as this implies a 10% chance of expiring in the money. 

The smaller the delta, the cheaper the option - but the lower your odds of making money. We can see this in the SPX (S&P 500 Index) options chain below for out of the money call options.

When I’m buying out of the money options naked, I like to target deltas in the ±0.30 to 0.60 range. For puts, delta is always negative, while calls have a positive delta.

Of course, there are a lot of variables at play, and these ideal deltas can’t apply to all trades.

LEAPS and Time Decay

If you’re going to buy LEAPS, it may be wise to exit your position before expiration. Time decay (theta) tends to accelerate around 45 DTE, as you can see in the chart below:

If you still want to hold your position, you can roll the LEAPS to a later expiration in one transaction using either a diagonal spread (change strike and month) or a calendar spread (change only the expiration).

Just remember, if you roll before the one-year mark on a winning trade, your gains will be taxed as short-term, so factor that into your decision.

LEAPS and Implied Volatility

An options contract is made up of intrinsic value and extrinsic value.

• Intrinsic value is simply how much an option is in the money by.
• Extrinsic value is what could happen, and it comes from time and Implied Volatility (IV).

If you’re buying an out of the money LEAPS option, the price is 100% extrinsic value. That’s why you want to buy LEAPS when IV is low but likely to rise.

To determine if IV is low, traders examine IV Rank, which indicates where today’s IV stands in relation to its range over the past year.

Here are a few simple rules of thumb to go by when it comes to IV Rank:

LEAPS and the Greeks

In options trading, the Greeks are a set of risk metrics that help estimate how an option’s price will respond to changes in key market variables. Here are the five most important Greeks to know:

• Delta – shows how much an option price changes for a $1 move in the stock.
• Gamma – shows how much delta shifts when the stock moves $1.
• Theta – shows how much an option loses value each day from time decay.
• Vega – shows how much an option price changes for a 1% change in implied volatility.
• Rho – shows how much the option price changes for a 1% change in interest rates.

And here is the relationship between LEAPS and these Greeks:

‍

^{⚠️ Besides the initial debit paid, be sure to factor in commissions and fees when calculating net profit or loss. These costs can reduce your overall return and should be included in every trade plan. Always read Characteristics and Risks of Standardized Options before trading options.}