Ken Trester

Short-Term Gains Using Long-Term Options

    Tweet This

For example, Netflix (NFLX) LEAP options in even years (2010, 2012, etc.) start with the root symbol WHU, which means that the NFLX Jan 20 LEAP Calls that are set to expire in 2010 have a ticker of WHUAD.

The WHU root symbol once belonged to January 2008 options, which became QNQ before those options expired. So, those NFLX Jan 20 Calls automatically became QNQAD in the trading accounts of those who hold them.

And in the next even-numbered year, 2010, the same process will take place and the same tickers will come onto the board again, provided that the company is still in business and its stock is trading in roughly the same area.

There's no work that needs to be done on the part of the trader when a LEAP symbol converts, but the reason the ticker has to change is so the currently active LEAP root symbol can be assigned to the series that is two years away from expiration.

After the conversion takes place, if someone would buy an option with the WHUAD ticker, they would be purchasing the NFLX Jan 20 Call -- the one with an expiration date of 2010, 2012, 2014, and so on, depending on when the option is purchased.

Particularly in the summer when the newest option series (i.e., two years out) appears on the board, you should be paying close attention to the options you're buying to ensure they're the right ones!

This extended period of time helps the option premium hold up better during a stock decline, whereas a nearer-term option (i.e., one set to come off the board during the coming expiration cycles) has less of that precious time value and therefore would have less chance of making a recovery. The LEAP, however, allows plenty of time for the stock, and thus the option, to regain its value and even charge ahead to higher highs.

However, a LEAP is more expensive than a shorter-term option because of these benefits. So, when you buy a LEAP, it is very important to set a mental stop-loss on the underlying stock so that you're not left holding a losing position for a long time to come.

If you're an option buyer and the stock closes below this stop loss, you should sell the LEAP. This will usually protect you from losing much or your entire option premium if the stock declines. An option buyer's major sin is to let time premium, and therefore profits, slip away.

This stop loss you use should be a "trailing stop," one that's just below the market value that will help you to preserve any profits that you gain along the way. As the option increases in price due to a rise in the stock, you keep moving up the stop-loss level so that it is never more than 5% or 10% below the stock price.

But if the stock price declines, you do not adjust the trailing stop. This way, if the stock declines from its high you will be able to sell the LEAP in plenty of time to preserve most of your profit.