This article is from the Investing Articles: Stocks and Options series.
The second strategy is actually an extension or "special case" of the first. The objective here is to identify profitable covered call opportunities in which the options are "LEAPS" (Long Term Equity Anticipation Securities). For our purposes, a "LEAP" may be defined as an option in which the expiration date is more than a year away. The formula used to calculate the annual return on monies invested when a "covered LEAP" is called away is the same as the one used for covered calls; however, the value of the premium should be greater and the length of time until the option expires is longer.
The advantages of this strategy are:
1. The larger premium gives more protection on the "downside."
2. There are less commissions to pay.
3. The investor will know exactly how much profit will be realized over a long period of time and thus can plan other strategies accordingly.
4. As the LEAP approaches the expiration date, the "time value" will begin to decay. This may present the investor with the opportunity to buy back the LEAP at a lower price. Thus he or she can keep the stock and still make a profit on the LEAP.
The disadvantages of this strategy are:
1. Investment monies are "tied up" for a long period of time.
2. If the stock goes down significantly in price early in the life of the LEAP, the investor will be "faced with some tough decisions." Should he or she: (1) continue to hold the position and "hope for the best" or (2) buy back the LEAP and sell the stock.