Ken Trester

Short-Term Gains Using Long-Term Options

by Ken Trester   04/02/09

Stock options are excellent speculative vehicles -- and the inexpensive, undervalued ones can give you an outstanding bang for your buck.

When you buy cheap puts and calls, they have the potential for unlimited upside if the stock trades in your favor, and the good news is that your losses are capped at the amount you invested. So, when you invest a small amount of money in call option or put option trades, it's the most you can lose!

You can also trade options as a replacement for buying stocks, which can give you far more leverage and help you to incur less risk as you participate in the stock market. This strategy can protect you from the risk of a stock market crash, as long as you don't go overboard.

To use options as surrogates for stocks, you must typically purchase in-the-money calls (that is, when the stock is trading above the option's strike price) that have minimal time value.

Time is crucial with options -- the more time your option has to move into the money -- or deeper in-the-money -- the more valuable it becomes.

But in-the-money options are expensive to purchase, and a big drawback to this trading technique is that if the stock experiences a sharp correction, much of your premium can collapse in a short amount of time.

Although you can't stop the clock, you can always buy more time.

To gain some protection against short-term market events that can impact your hard-earned premium, you can buy out-of-the-money long-term options (also called LEAPS) to take advantage of time value.

LEAPS are long-term options that can last for up to two and a half years, so this can be the next-best thing to owning a stock for a brief, defined period. In fact, many traders end up holding LEAPS for longer than they own stocks!

They are no different than a regular short-term option; the only "real" difference is that, when they come closer to expiration, their ticker changes and the LEAP ticker is reassigned to the next cycle.